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PRINCIPLES  OF  ECONOMICS 


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TORONTO 


PRINCIPLES  OF  ECONOMICS 


F/W. 


BY 


TAUSSIG 


HENRY   LEE   PROFESSOR   OF   ECONOMICS 
IN  HARVARD   UNIVERSITY 


VOLUME  I 
SECOND  EDITION  REVISED 


ff  orfc 

THE  MACMILLAN   COMPANY 
1917 

All  righU  reserved 


.i 


COPYRIGHT,  1911,  1915, 
Bv  THE  MACMILLAN  COMPANY. 


Set  up  and  electrotyped.  Published  September,  1911.  Reprinted 
November,  December,  1911;  August,  October,  1912;  February, 
September,  November  19131 

Second  edition  revised  January,  1915.     Reprinted  October, 
December,  1915;  August,  1916;  January,  August,  1917. 


NottoooB 

J.  8.  Cushlnp  Co.  —  Berwick  &  Smith  Co. 
Norwood,  Mass.,  U.S.A. 


PATRI  •  DILECTO 
FILIVS  •  GRATVS 


PREFACE 

I  HAVE  tried  in  this  book  to  state  the  principles  of  economics 
in  such  form  that  they  shall  be  comprehensible  to  an  educated 
and  intelligent  person  who  has  not  before  made  any  systematic 
study  of  the  subject.  Though  designed  in  this  sense  for  begin- 
ners, the  book  does  not  gloss  over  difficulties  or  avoid  severe 
reasoning.  No  one  can  understand  economic  phenomena  or  pre- 
pare himself  to  deal  with  economic  problems  who  is  unwilling  to 
follow  trains  of  reasoning  which  call  for  sustained  attention.  I 
have  done  my  best  to  be  clear,  and  to  state  with  care  the  grounds 
on  which  my  conclusions  rest,  as  well  as  the  conclusions  them- 
selves, but  have  made  no  vain  pretense  of  simplifying  all  things. 

The  order  of  the  topics  has  been  determined  more  by  conven- 
ience for  exposition  than  by  any  strict  regard  for  system.  In 
general,  a  subject  has  been  entered  on  only  when  the  main  conclu- 
sions relating  to  it  could  be  followed  to  the  end.  Yet  so  close  is 
the  connection  between  the  different  parts  of  economics  that  it  has 
been  necessary  sometimes  to  go  part  way  in  the  consideration  of 
matters  on  which  the  final  word  had  to  be  reserved  for  a  later  stage. 
Taxation  has  offered,  as  regards  its  place  in  the  arrangement,  per- 
haps the  greatest  difficulties.  It  is  so  closely  connected  with  eco- 
nomics that  some  consideration  of  it  seemed  essential ;  whereas 
public  finance  in  the  stricter  sense,  whose  problems  are  political 
quite  as  much  as  economic,  has  been  omitted.  Yet  a  suitable 
place  for  taxation  was  not  easy  to  find.  I  concluded  finally  to 
put  the  chapters  on  this  subject  at  the  very  close,  even  though  they 
may  have  the  effect  of  an  anticlimax,  coming  as  they  do  after 
those  on  socialism. 

The  book  deals  chiefly  with  the  industrial  conditions  of  modern 
countries,  and  most  of  all  with  those  of  the  United  States.  Eco- 
nomic history  and  economic  development  are  not  considered  in 
any  set  chapters,  being  touched  only  as  they  happen  to  illustrate 
one  or  another  of  the  problems  of  contemporary  society.  Some 
topics  to  which  economists  give  much  attention  in  discussion 
among  themselves  receive  scant  attention  or  none  at  all.  I  have 

vii 


viii  PREFACE 

omitted  entirely  the  usual  chapters  or  sections  on  definition, 
methodology,  and  history  of  dogma ;  and  have  said  little  on  such  a 
topic  as  the  subjective  theory  of  value,  which  in  my  judgment 
is  of  less  service  for  explaining  the  phenomena  of  the  real  world 
than  is  supposed  by  its  votaries.  These  matters  and  others  of 
the  same  sort  are  best  left  to  the  professional  literature  of  the 
subject.  I  hope  this  book  is  not  undeserving  the  attention  of 
specialists;  but  it  is  meant  to  be  read  by  others  than  specialists. 

Though  not  written  on  the  usual  model  of  textbooks,  and  not 
planned  primarily  to  meet  the  needs  of  teachers  and  students, 
the  book  will  prove  of  service,  I  hope,  in  institutions  which  offer 
substantial  courses  in  economics.  The  fact  that  it  is  addressed 
to  mature  persons,  not  to  the  immature,  should  be  an  argument 
in  favor  of  such  use  rather  than  against  it.  Being  neither  an 
encyclopedic  treatise  nor  a  textbook  of  the  familiar  sort,  it  offers 
no  voluminous  footnotes  and  no  detailed  directions  for  collateral 
reading.  When  facts  and  figures  not  of  common  knowledge  have 
been  cited,  my  sources  of  information  have  been  stated.  At  the 
close  of  each  of  the  eight  Books  into  which  the  whole  is  divided, 
I  have  given  suggestions  for  further  reading  and  study,  mention- 
ing the  really  important  books  and  papers. 

I  have  expressed  in  the  text,  as  occasion  arose,  my  obligations 
to  the  contemporary  thinkers  from  whom  I  have  derived  most 
stimulus.  For  great  aid  in  revising  the  manuscript  and  proof,  on 
matters  both  of  form  and  substance,  I  am  indebted  to  my  colleagues 
Drs.  B.  F.  Foerster  and  E.  E.  Day  of  Harvard  University. 

F.  W.  TAUSSIG. 
HARVARD  UNIVERSITY, 
March,  1911. 


NOTE  TO   THE  SECOND  EDITION 

IN  the  present  edition  changes  have  been  made  with  the  design 
of  bringing  to  date  the  discussion  of  some  important  problems. 
The  chapter  on  banking  in  the  United  States  has  been  entirely 
re-written ;  as  it  now  stands,  it  includes  a  description  of  the  Fed- 
eral Reserve  Bank  system  and  a  consideration  of  the  principles 
underlying  the  new  legislation.  The  chapter  on  trusts  and  com- 
binations has  been  largely  re-written,  with  reference  to  the  laws 
enacted  in  1914.  Considerable  revision  has  been  made  in  the 
chapter  on  workmen's  insurance,  calling  attention  to  the  note- 
worthy steps  taken  of  late  years  in  England  and  the  United 
States.  The  chapters  on  taxation  and  especially  on  income  taxes, 
and  on  some  other  topics,  have  been  similarly  brought  to  date. 

So  far  as  concerns  questions  of  principle  and  general  reasoning, 
the  text,  barring  emendations  on  minor  points,  has  been  left  as 
when  first  published. 

F.  W.  TAUSSIG. 

December,  1914. 


CONTENTS 
BOOK  I 

THE  OBGANIZATION   OF  PRODUCTION 

CHAPTER   1  VOL.I 

PAGES 

WEALTH  AND  LABOR 3-14 

Section  1.  The  subject  matter  of  economics,  3  —  Sec.  2.  Wealth  ; 
free  goods;  economic  goods.  Wealth  and  welfare,  6  —  Sec.  3. 
Goods  may  become  economic  through  mere  scarcity ;  but  commonly 
do  so  because  of  the  exertion  of  labor,  7  —  Sec.  4.  Activity  may  be 
irksome  or  pleasurable.  Labor  usually  is  continuous,  monotonous, 
irksome,  8  —  Sec.  6.  Some  sorts  of  labor  always  pleasurable,  10  — 
Sec.  6.  The  irksomeness  of  most  labor  to  be  lessened  by  better  gen- 
eral opinion,  and  by  greater  leisure  through  shorter  hours,  12. 

CHAPTER  2 

PRODUCTIVE  AND  UNPRODUCTIVE  LABOR 15-29 

Section  1.  Labor  given  to  material  objects  deemed  alone  produc- 
tive by  earlier  English  economists.  Objections  to  this  view,  15  — 
Sec.  2.  Labor  creates  utilities  only  ;  all  labor  that  issues  in  utility 
is  productive.  Is  there  nonmaterial  wealth  ?  17  —  Sec.  3.  Is  there 
any  unproductive  labor  ?  Labor  given  to  things  harmful,  20  — 
Sec.  4.  Labor  of  judges  and  lawyers  ;  of  soldiers,  23  —  Sec.  5.  Pred- 
atory labor.  "Business."  The  law  and  unproductive  labor,  26. 

CHAPTER  3 

THE    DIVISION   OF  LABOR    AND    THE    DEVELOPMENT   OF  MODERN  IN- 
DUSTRY       ._ 30-48 

Section  1.  Two  forms  of  the  division  of  labor :  the  simpler  and 
the  more  complex,  30  —  Sec.  2.  Advantages  from  the  simpler  form  ; 
dexterity,  continuity,  adaptation  to  aptitudes,  31  —  Sec.  3.  Advan- 
tage from  the  more  complex  form  :  the  development  of  machinery. 
The  industrial  revolution  of  the  eighteenth  century.  The  use  of 
nature's  power,  83  — Sec.  4.  Division  of  labor  means  unconscious 
cooperation.  Exchange,  37  —  Sec.  5.  Exchange  formerly  covered 
a  limited  economic  area.  Cheap  transportation  (railways)  makes 
the  area  wide,  38  —  Sec.  6.  Wider  markets  bring  more  minute  divi- 

jri 


xii  CONTENTS 

VOL.  1 
PAGES 

sion  of  labor.  Illustration  from  butcher's  trade,  41  —  Sec.  7.  The 
geographical  division  of  labor,  illustrated  by  the  United  States  and 
Great  Britain,  43  —  Sec.  8.  Two  sorts  of  gain  from  geographical 
division  of  labor,  45. 

CHAPTER   4 

LARGE-SCALE  PRODUCTION 49-66 

Section  1.  Growth  of  large-scale  production  illustrated  by  certain 
industries  :  cotton  goods,  iron,  agricultural  implements,  49  — 
Sec.  2.  Advantages  of  large-scale  production :  use  of  machinery, 
saving  in  general  expenses,  buying  and  selling,  utilization  of  by- 
products, experimenting,  52  —  Sec.  3.  Limitations,  chiefly  from 
difficulties  of  superintendence.  The  case  of  agriculture.  Other 
industries.  Scarcity  of  able  managers  as  a  cause  of  limitation,  55 
—  Sec.  4.  Combination,  horizontal  and  vertical.  The  Steel  Corpo- 
ration as  an  example.  Other  examples.  The  tendency  to  vertical 
combination  less  strong  than  that  to  horizontal,  69  —  Sec.  6.  Com- 
petition often  wasteful ;  though  the  waste  is  less  than  it  seems. 
Combination  rules  only  over  part  of  industry,  65. 

CHAPTER  5 

CAPITAL 67-85 

Section  1.  Production  is  spread  over  time.  This  fact  disguised 
by  the  division  of  labor.  Increasing  use  of  plant  and  machinery 
in  modern  times,  67  —  Sec.  2.  Producer's  wealth  and  consumer's 
wealth;  capital,  69  —  Sec.  3.  Capital  rests  on  a  surplus,  71  — 
Sec.  4.  In  what  sense  capital  rests  on  saving.  Hoarding  contrasted 
with  saving  for  investment,  72  —  Sec.  6.  Investment  means  advances 
to  laborers.  Inequality  of  possessions  in  relation  to  advances. 
Middlemen  for  investment  and  advances,  74  —  Sec.  6.  The  mainte- 
nance of  capital,  as  well  as  its  creation,  involves  saving,  77  — 
Sec.  7.  Some  corollaries.  Saving  usually  irksome,  and  undertaken 
for  a  reward  ;  interest,  79  —  Sec.  8.  Capital  and  the  owner's  inten- 
tion, 80  —  Sec.  9.  Saving  and  investment  do  not  necessarily  lead 
tc  the  making  of  capital.  Spendthrift  loans.  Government  debts, 
81  —  Sec.  10.  Some  distinctions  :  capital  to  the  individual  and 
capital  to  the  community.  "Capital"  and  "capital  goods,"  83. 


CHAPTER  6 
THE  CORPORATE  ORGANIZATION  OF  INDUSTRY        ....          86-96 

Section  1.  Partnerships  and  corporations.  Limited  liability. 
Corporations  from  the  legal  point  of  view  and  from  the  economic, 
86  —  Sec.  2.  Advantages  from  corporate  organization.  Large- 


CONTENTS  xiii 

VOL.  I 
PASM 

scale  operations  facilitated ;  new  and  venturesome  investments 
promoted;  stimulus  to  savings  and  investment,  89  —  Sec.  3.  Ease 
of  transfer  serves  to  divide  risks  and  so  promote  investments,  and 
to  bring  control  into  capable  hands.  But  it  leads  to  great  evils : 
overreaching,  stock  exchange  gambling,  control  by  the  unscrupu- 
lous, 91  —  Sec.  4.  Increasing  importance  of  financial  middlemen. 
Power  of  trusted  bankers  and  managers,  95  —  Sec.  5.  High  security 
of  much  corporate  property  makes  the  leisure  class  more  perma- 
nent, 96. 

CHAPTER  7 

SOME  CAUSES  AFFECTING  PRODUCTIVENESS    .         ...»        .        97-110 

Section  1.  The  effect  of  high  wages  (abundant  food)  on  the  pro- 
ductivity of  labor.  High  wages  in  the  main  a  result,  not  a  cause, 
of  efficiency,  97  —  Sec.  2.  Effects  of  skill  and  intelligence  on  pro- 
ductivity. General  education.  Technical  education,  in  its  effect 
for  the  individual  and  for  the  community,  101  —  Sec.  3.  Leader- 
ship. The  business  man ;  the  man  of  science.  Freedom  and 
mobility  as  promoting  leadership.  The  motives  to  leadership,  105 
— Sec.  4.  The  immaterial  equipment  of  a  community ;  how  affected 
by  training  and  by  inheritance,  108. 

REFERENCES  ON  BOOK  I          •'       .    "    .         .         .         .         .         .         .     110 


CHAPTER   8 

INTRODUCTORY  :  EXCHANGE,  VALUE,  PRICE 118-119 

Section  1.  Exchange  the  consequence  of  the  division  of  labor,  113 
—  Sec.  2.  Money  as  the  medium  of  exchange,  114  —  Sec.  3.  Value 
and  utility.  The  notion  of  value  in  exchange,  116 — Sec.  4.  A 
general  rise  in  values  ;  a  general  rise  in  prices.  Stability  in  general 
prices  provisionally  assumed,  117. 

CHAPTER  9 

VALUE  AND  UTILITY       .        .        .        ..  ;     /      .        .        .        .      120-137 

Section  1.  Utility  a  necessary  condition  of  value ;  but  value  not 
proportional  to  utility,  120  —  Sec.  2.  Increase  of  supply  brings  low- 
ering of  value  ;  because  of  differences  of  means,  and,  fundamentally, 
because  of  the  law  of  diminishing  utility.  Effects  of  varying  the 
commodities  supplied.  Possible  exceptions  to  the  general  principle, 
124  —  Sec.  3.  Total  utility  and  marginal  utility,  124  —  Sec.  4.  Value 
depends  on  marginal  utility.  Qualifications  and  explanations. 
The  marginal  utility  of  money,  126  —  Sec.  5.  Consumer's  surplus. 


xiv  CONTENTS 

TOL. 

PAH 

Sundry  limitations  on  its  significance  and  on  the  possibility  of  meas- 
uring it,  128  —  Sec.  6.  How  state  and  measure  the  income  of  a 
community  ?  133  —  Sec.  7.  The  law  of  diminishing  utility  points 
to  the  conclusion  that  inequality  lessens  maximum  happiness,  135. 


CHAPTER   10 

MABKET  VALUE.     DEMAND  AND  SUPPLY 138-158 

Section  1.  The  conditions  of  demand  and  the  demand  curve. 
Demand  possibly  discontinuous,  usually  continuous,  138  —  Sec.  2. 
How  value  is  determined  by  marginal  utility,  for  a  fixed  supply. 
The  equation  of  demand  and  supply,  143  —  Sec.  3.  A  varying  sup- 
ply: the  equilibrium  of  demand  and  supply,  144  —  Sec.  4.  How 
far  the  supposition  of  a  fixed  supply,  how  far  that  of  a  varying 
supply,  conforms  to  the  facts.  The  circumstances  that  act  on  daily 
and  on  seasonal  prices,  146  —  Sec.  5.  Qualifications  as  to  the 
market  value  of  capital  goods,  151  —  Sec.  6.  Retail  prices  seem  to 
follow  wholesale  prices,  but  in  the  end  govern  wholesale  prices. 
The  advantage  of  fixed  retail  prices,  153  —  Sec.  7.  Current  market 
prices  are  what  people  commonly  mean  when  they  speak  of  "  fair" 
prices,  155  —  Sec.  8.  Sporadic  cases  where  value  is  affected  by 
utility  to  sellers,  156. 

CHAPTER  11 

SPECULATION 159-169 

Section  1.  The  fundamental  effect  of  speculation  is  to  mitigate 
fluctuations,  159 — Sec.  2.  Dealing  in  futures  lessens  fluctuations, 
161  —  Sec.  3.  Exchanges  ;  standardizing,  163  —  Sec.  4.  The  evils 
of  speculation  :  gambling ;  unproductive  labor,  165  —  Sec.  5.  The 
evils  of  stock  exchange  speculation,  167. 


CHAPTER   12 

VALUE  UNDER  CONSTANT  COST       .......      170-179 

Section  1.  The  simplest  case  first  assumed  :  a  supply  absolutely 
flexible,  free  competition,  constant  cost.  Value  then  determined 
by  cost,  170 — Sec.  2.  Illustration  by  diagram,  172  —  Sec.  3.  The 
proposition  points  to  a  tendency  or  approximation  only ;  to  what 
happens  in  a  "static,"  not  in  a  "dynamic,"  state,  174— Sec.  4. 
Some  explanations  and  qualifications.  Flexibility  in  supply  never 
perfect,  often  much  impeded.  Changes  in  demand  from  fashion. 
How  far  free  competition  holds.  Good  will.  A  small  surplus 
above  cost  price  may  mean  large  profits,  176. 


CONTENTS  xv 

CHAPTER   13  TOL.i 

rjkam 
VALTTE  AND  VABYING  COSTS.    DIMINISHING  RETURNS  .        .        .      180-188 

Section  1.  The  equilibrium  of  value  where  marginal  utility  and 
marginal  cost  balance.  The  simile  of  the  scissors,  180  —  Sec.  2. 
Permanent  variations  in  cost  affect  long-run  value  differently  from 
temporary  variations,  183  —  Sec.  3.  Diminishing  returns,  185  — 
Sec.  4.  Permanent  variations,  or  diminishing  returns,  appear  most 
in  the  extractive  industries,  186. 

CHAPTER   14 

VALUE  AND  INCREASING  RETURNS 189-198 

Section  1.  The  equilibrium  of  supply  and  demand  under  increas- 
ing returns.  How  the  case  differs  from  that  of  diminishing  returns. 
Long-run  results  considered,  189  —  Sec.  2.  What  industries  show 
increasing  returns.  Causes  of  the  tendency.  External  economies. 
Localization  of  industry ;  labor  supply,  191  —  Sec.  3.  Internal 
economies,  if  continuing  indefinitely,  lead  to  monopoly,  193  —  Sec. 
4.  Possibility  of  several  points  of  equilibrium.  Increasing  returns 
commonly  come  slowly,  but  sometimes  fast,  195. 

CHAPTER   15 

MONOPOLY  VALUE 199-217 

Section  1.  Monopoly  affects  price  through  limitation  of  supply. 
This  proposition  qualified  as  to  transactions  between  middlemen, 
especially  as  to  producer's  capital,  199 — Sec.  2.  How  price  is  fixed 
if  a  monopolist  has  a  fortuitous  supply ;  how,  if  he  produces  his 
supply  at  constant  cost.  Monopoly  profit.  Destruction  of  part  of 
the  supply  possible,  but  not  probable.  Diamond  mining  as  illus- 
trating monopoly  price,  201  —  Sec.  3.  Monopoly  price  under  in- 
creasing returns.  Copyrighted  books  as  illustrations.  Monopoly 
price  under  diminishing  returns,  205  —  Sec.  4.  Possibility  of  vary- 
ing prices  under  monopoly,  usually  disguised.  Copyrighted  books  ; 
telephone  rates.  Converse  case  of  uniform  prices  under  monopoly, 
208  —  Sec.  5.  "Dumping"  explained  by  monopoly,  211  —  Sec.  6. 
Unqualified  monopoly  rare  ;  various  limitations  and  qualifications, 
212  —  Sec.  7.  "Corners"  (of  a  season's  supply)  do  not  per  se 
affect  price  to  consumers,  but  affect  dealers  and  speculators.  Some 
among  the  consumers  may  be  affected  by  corners.  Successful 
corners  rare,  214. 

CHAPTER  16 

JOINT  COST  AND  JOINT  DEMAND .      218-224 

Section  1.  Joint  cost :  effect  of  increase  or  decrease  in  demand. 
Influence  of  separable  items  of  expense.  "By-products."  Com- 


xvi  CONTENTS 

VOI..  I 
PAOIS 

plex  case  where  both  monopoly  and  joint  cost  exist.  Influence  of 
large  plant,  218  —  Sec.  2.  Joint  demand.  The  constituent  most 
limited  in  supply  feels  most  the  effect  of  an  increase  of  demand. 
Labor  in  building  trades  as  an  illustration.  Joint  demand  usually 
causes  peculiarities  less  enduring  than  those  arising  from  joint 
cost,  221. 
REFERENCES  ON  BOOK  II 224 

BOOK  III 

MONET  AND   THE  MECHANISM  OF  EXCHANGE 
CHAPTER   17 

THE  PRBCIOCS  METALS.     COINAGE         .  ...      227-235 

Section  1.  The  precious  metals  the  main  constituents  of  the 
circulating  medium,  227  —  Sec.  2.  Qualities  that  have  caused  them 
to  be  selected  for  monetary  use  :  luster,  freedom  from  deterioration, 
limited  supply.  Their  value  and  monetary  use  now  rest  largely  on 
convention,  228  —  Sec.  3.  Coinage  a  public  function.  Free  coinage; 
bullion  and  coin  interchangeable.  The  mint  price  of  gold,  230  — 
Sec.  4.  Plentifulness  of  money  is  per  se  a  matter  of  indifference,  233. 

CHAPTER   18 

QUANTITY  OF  MONEY  AND  PRICES 236-251 

SECTION  1.  The  value  of  money  is  inverse  to  its  quantity,  236  — 
Sec.  2.  Qualifications  of  this  principle.  Flow,  or  rapidity  of  circu- 
lation, of  money  and  of  goods,  238  —  Sec.  3.  Diversion  of  specie 
from  monetary  use  through  consumption  in  the  arts.  Effects  of 
rise  and  fall  in  prices  ;  changes  in  industrial  demand.  Tendency 
to  sharper  separation  of  monetary  and  industrial  use,  242  —  Sec.  4. 
Diversion  of  specie  from  the  monetary  supply  of  Western  countries 
by  its  flow  to  the  East,  245  —  Sec.  5.  An  increase  in  the  supply  of 
money  does  not  ordinarily  affect  people's  ways  of  using  it,  but 
may  do  so  when  barter  is  in  process  of  being  superseded  by  money 
exchange,  as  was  the  case  in  the  sixteenth  century,  247  —  Sec.  6. 
The  conclusions  of  this  chapter,  though  simple  and  provisional,  hold 
good  in  essentials  for  more  complicated  conditions,  250. 

CHAPTER  19 

THB  COST  OF  SPECIB  IN  RELATION  TO  ITS  VALUE        .        .         .      252-264 

Section  1.  The  determination  of  the  value  of  the  precious  metals 
by  their  marginal  cost  is  impeded  by  (1)  their  durability  ;  (2)  their 
irregular  and  aleatory  production  ;  (3)  the  unexpected  occurrence 
of  new  sources  of  supply,  262  —  Sec.  2.  Illustrations  from  history. 
The  American  specie  of  the  sixteenth  century,  and  the  price  revo- 


CONTENTS  xvii 

VOL.  I 
PAGES 

lution  of  1550-1650,  255  —  Sec.  3.  The  Australian  and  Californian 
gold  discoveries  of  1850,  and  their  comparatively  slight  effect  on 
prices,  258  —  Sec.  4.  The  increase  of  gold  supply  since  1890,  and  its 
effect  on  prices,  260  —  Sec.  5.  For  considerable  periods,  the  value  of 
gold  determines  what  shall  be  the  marginal  source  of  supply  ;  it  is 
not  the  marginal  source  of  supply  which  determines  its  value,  262. 

CHAPTER  20 

BIMETALLISM  .       V 265-273 

Section  1.  Both  metals  long  used  side  by  side.  The  fully  devel- 
oped double  standard  illustrated,  265  —  Sec.  2.  Mint  ratio  and 
market  ratio ;  overvalued  and  undervalued  metal.  Tendency  of 
the  overvalued  metal  to  displace  the  undervalued,  illustrated  by  the 
experience  of  the  United  States,  266  —  Sec.  3.  "Gresham's  Law," 
269  —  Sec.  4.  Subsidiary  coin  and  its  proper  regulation,  271. 

CHAPTER   21 

BIMETALLISM  (continued).     THE  DISPLACEMENT  OF  SILVER        .      274-289 

Section  1.  The  double  standard  in  France,  and  elsewhere,  until 
recent  times.  Its  tendency  to  keep  the  relative  value  of  gold  and 
silver  stable.  This  effect  produced  by  French  bimetallism,  1825- 
1873,  274  —  Sec.  2.  New  situation  after  1870.  Free  coinage  of  silver 
ceased  in  1873.  Thereafter,  gold  the  standard  in  France  and  the 
Latin  Union,  277  —  Sec.  3.  German  thalers,  280  —  Sec.  4.  The 
United  States ;  acts  of  1873, 1878,  1890,  and  1893.  Silver  dollars 
and  silver  certificates,  281  —  Sec.  5.  Cessation  of  free  coinage  in 
British  India  in  1893.  Decline  in  the  price  of  silver,  284  —  Sec.  6. 
Would  universal  bimetallism  conduce  to  a  stable  ratio  between  gold 
and  silver  ?  286  —  Sec.  7.  Would  universal  bimetallism  conduce  to 
stable  prices  ?  288. 

CHAPTER   22 

CHANGES  IN  PRICES .'        .        .      290-309 

Section  1.  Changes  in  prices  measured  by  index  numbers.  The 
simple  arithmetical  mean,  290  —  Sec.  2.  Weighted  index  numbers. 
Medians.  Illustration  from  prices  in  the  United  States,  1890-1906, 
291  —  Sec.  3.  Effects  of  changes  in  prices  on  creditors  and  debtors, 
297  —  Sec.  4.  Peculiar  problem  where  the  movement  of  prices  is 
different  from  that  of  money  incomes,  298  —  Sec.  5.  A  multiple 
standard  impracticable,  302  —  Sec.  6.  Rising  prices  seem  to  cause 
prosperity,  falling  prices  adversity.  This  due  to  the  slower  advance 
of  money  wages,  and  the  consequent  gains  or  losses  of  employers 
of  labor,  303  —  Sec.  7.  Changes  in  prices  are  accompanied  by 
changes  in  the  rate  of  interest.  The  parallel  movement  due,  not 


xviii  CONTENTS 


to  any  conscious  adjustment,  but  in  part  to  the  effects  on  business 
profits,  in  part  to  the  general  causes  of  oscillations  in  prices,  307. 

CHAPTER  23 

GOVERNMENT  PAPER  MONET 310-330 

Section  1.  Inconvertible  paper,  or  fiat  money,  dependent  on  an 
established  habit  of  using  paper  money.  Its  value  depends  on  its 
quantity,  provided  it  circulates  freely.  Possible  failure  to  circulate 
freely ;  possible  collapse  from  extreme  overissue,  310  —  Sec.  2. 
Paper  drives  out  specie.  Depreciation  from  overissue.  The  specie 
premium  does  not  measure  real  depreciation  with  accuracy.  Pros- 
pect of  redemption  affects  specie  premium,  314  —  Sec.  3.  Illustration 
from  United  States  experience  in  1862-1879,  318  —  Sec.  4.  Over- 
issue rarely  avoided.  On  what  terms  resumption  of  specie  pay- 
ments should  be  undertaken  after  a  period  of  depreciation,  320  — 
Sec.  5.  "Inconvertible  specie."  The  rupee  in  British  India;  sil- 
ver florins  in  Austria,  323  —  Sec.  6.  International  paper  ?  The 
grounds  for  using  gold,  326  —  Sec.  7.  Convertible  government 
paper.  United  States  certificates  of  deposit.  United  States  notes, 
or  greenbacks.  Other  cases  of  convertible  paper,  326. 

CHAPTER   24 

BANKING  AND  THE  MEDIUM  OF  EXCHANGE     .....      831-347 

Section  1.  Two  functions  of  banks :  in  relation  to  investment 
and  to  the  circulating  medium.  The  investment  operations,  331  — 
Sec.  2.  Bank  notes,  payable  on  demand.  The  safer  they  are,  the 
less  likely  to  be  presented  for  payment.  They  tend  to  displace 
specie.  Effect  of  prohibition  of  small  denominations,  333  —  Sec.  3. 
Deposits  may  arise  through  cash  placed  in  a  banker's  custody ;  but 
may  be  created.  The  mode  of  creating  and  maintaining  deposits, 
in  connection  with  loans.  The  check  is  the  deposit  in  act  of  use,  336 
—  Sec.  4.  The  offsetting  of  checks,  chiefly  through  clearing  houses. 
Great  development  of  clearing  houses,  341  —  Sec.  5.  Deposits  as  a 
circulating  medium,  343  —  Sec.  6.  Effects  of  deposit  banking  on 
the  circulation  of  money  ;  on  that  of  bank  notes,  345. 

CHAPTER  25 

BANKING  OPERATIONS „  348-369 

Section  1.  Cash  in  banks'  vaults  tends  to  be  reduced  to  the  mini- 
mum. The  other  resources  should  be  of  a  liquid  sort.  Discount  of 
commercial  paper,  loans  on  collateral  securities,  "outside  paper." 
Growing  tendency  to  combine  these  operations  with  investment 
operations,  348  —  Sec.  2.  Relation  of  the  rate  of  discount  (interest) 


XIX 

rot.  r 
MAM 

to  the  quantity  of  cash  held  by  banks.      Greater  fluctuations  on 
demand  loans  ;    their  connection  with  speculation,  352  —  Sec.  3. 
Qualities  of  a  successful  banker ;  importance  of  good  will  for  the 
profits  of  banking,  356  —  Sec.  4.  Banks  do  not  create  capital,  but 
affect   the   direction   in  which   investment  shall   be    made,   and 
exercise  a  selective  influence  among  business  men.    Their  social 
utility  stands  and  falls  with  the  utility  of  the  system  of  private 
property,  357. 

CHAPTER   26 
CENTRALIZED  BANKING  SYSTEMS    .         .         .        .         ...      360-374 

Section  1.  Need  of  regulating  issue  of  bank  notes.  Centralization 
of  issue  in  Europe,  360  —  Sec.  2.  The  Bank  of  France  the  simplest 
case.  Its  semiprivate  organization  ;  monopoly  of  note  issue  ;  great 
stock  of  specie ;  advantages  and  disadvantages,  361  —  Sec.  3.  The 
Bank  of  England  under  the  act  of  1844.  Issue  and  Banking  depart- 
ments. Relation  to  other  banks  of  deposit ;  large  cash  holdings. 
Procedure  in  times  of  crisis,  365  —  Sec.  4.  The  Reichsbank  of 
Germany.  Conditions  of  note  issue.  Relation  to  other  banks,  370. 

CHAPTER  27 
THE  BANKING  SYSTEM  OF  THE  UNITED  STATES      ....     375-385 

Section  1.  The  old  national  bank  system.  Note  issue  secured  by 
bonds,  375  —  Sec.  2.  Regulation  of  deposits;  requirements  as  to 
reserves  under  the  old  system.  The  Federal  Reserve  Banks ;  new 
requirements.  Are  there  still  grounds  for  compelling  all  banks  to 
hold  stated  reserves  ?  377  —  Sec.  3.  The  Federal  Reserve  Board ; 
its  large  powers,  especially  as  regards  the  issue  of  Federal  reserve 
notes,  383  —  Sec.  4.  Absence  of  branch  banking ;  great  numbers  of 
scattered  independent  institutions.  Advantages  and  disadvantages 
of  such  decentralization,  384. 

CHAPTER   28 

SOME  PROBLEMS  OF  LEGISLATION  ON  BANKING     ....      386-399 

Section  1.  Grounds  for  special  protection  of  notes.  Legal  position 
of  note  holders  and  depositors.  Some  degree  of  protection  is  settled 
in  the  United  States  ;  further  protection,  as  by  deposit  insurance  or 
guarantee,  is  not  out  of  the  question,  386  —  Sec.  2.  An  elastic  cur- 
rency. Grounds  on  which  elasticity  is  desirable ;  adaptability  to 
fluctuating  needs,  and  permeation  of  credit  facilities.  Failure  to 
secure  these  gains  under  the  national  banking  system,  390  —  Sec.  3. 
Advantages  or  disadvantages  of  central  banks.  Security  of  notes 
not  necessarily  greater.  Pecuniary  profit  to  government  negligible. 
Support  to  public  in  time  of  crisis  of  high  importance.  Lack  of 
flexibility  a  drawback,  though  one  of  lessening  importance  in  the 
United  States,  393  —  Sec.  4.  The  possibility  of  political  entangle- 
ment a  grave  consideration  in  the  United  States,  396. 


xx  CONTENTS 

CHAPTER   29  VOL.! 

PAGES 

CRISES  AND  INDUSTRIAL  DEPRESSION 400-411 

Section  1.  Two  phases  of  crises:  industrial  depression  and  finan- 
cial collapse.  Periodicity  of  crises  exaggerated,  but  regularity  of 
recurrence  unmistakable.  General  features,  400  —  Sec.  2.  Indus- 
trial depression  due  to  maladjustment  in  the  division  of  labor,  and 
especially  in  the  making  of  new  capital.  Railways  ;  iron  and  steel 
production,  403  —  Sec.  3.  The  psychological  factor;  the  contagion 
of  business  optimism  and  depression.  The  part  played  by  mer- 
chants and  retail  dealers,  404  —  Sec.  4.  During  the  period  of  de- 
pression, the  machinery  of  production  and  exchange  is  out  of  gear. 
The  cause  and  sequence  of  revival,  406  —  Sec.  5.  Maladjustment  in 
investment ;  making  of  new  capital  beyond  the  limits  set  by  avail- 
able savings.  Influence  of  corporate  securities,  408. 

CHAPTER  30 

FINANCIAL  PANICS  .  412-426 

Section  1.  Panics  as  to  business  men.  Interlacing  debts  and 
credits,  and  possibility  of  general  collapse.  Demand  for  accommo- 
dation in  times  of  crisis,  412  —  Sec.  2.  Position  of  the  banks :  de- 
mands for  loans  and  for  cash.  Need  of  a  bold  policy.  Aid  which  a 
central  bank  can  give,  413  —  Sec.  3.  Peculiar  dangers  in  the  United 
States,  from  the  wide  diffusion  of  deposit  banking.  Clearing  house 
action  when  an  individual  bank  is  threatened.  Difficulties  when  all 
the  banks  are  threatened,  416  —  Sec.  4.  Former  devices  for  dealing 
with  panics,  through  combined  action  and  clearing  house  certifi- 
cates, inadequate  in  the  United  States.  Severity  of  the  panics  of 
1873,  1893,  1907.  The  Federal  Reserve  system  designed  as  a  rem- 
edy, 418  —  Sec.  6.  Industrial  evils  of  crises  hard  to  remedy.  In 
the  main,  inevitable  concomitants  of  private  industry,  423. 

CHAPTER   31 

THE  THEORY  OF  PRICES  ONCE  MORE 427-445 

Section  1.  Credit  ordinarily  does  not  supplant  money,  but  post- 
pones its  use.  For  short  periods,  extension  of  credit  per  se  may 
influence  prices,  427  —  Sec.  2.  Credit  in  the  form  of  negotiable 
paper,  especially  bank  notes,  may  be  a  complete  substitute  for 
money.  Credit  through  offsetting  of  transactions  completely  sup- 
plants money.  The  clearing  house  does  this  on  a  great  scale,  428  — 
Sec.  3.  Prices  depend  on  purchasing  power  in  terms  of  money,  — 
not  only  specie,  but  paper  money,  credit,  bank  notes,  deposits. 
Peculiar  problem  as  to  bank  money,  especially  deposits :  inter- 
dependence of  the  volume  of  purchasing  power  and  the  volume  of 


CONTENTS  xxi 

YOU  I 
FA6U 

transactions,  430  —  Sec.  4.  How  the  volume  of  deposits  depends  on 
the  quantity  of  specie  ;  from  (a)  direct  necessity,  (6)  binding  cus- 
tom, (c)  legal  requirement,  432  —  Sec.  6.  (d)  Interaction  of  de- 
posits, notes,  specie,  435  —  Sec.  6.  (e)  The  temper  of  the  business 
community,  437  —  Sec.  7.  Influence  of  foreign  trade.  Prices  in 
credit-using  and  deposit-using  countries  affected  by  prices  in  other 
countries,  439  —  Sec.  8.  Illustration  of  the  preceding  principles, 
from  analysis  of  the  way  in  which  an  increase  of  gold  supply  affects 
prices,  441  —  Sec.  9.  Schemes  for  regulation  of  prices  through  index 
numbers  and  increase  or  decrease  of  paper  money.  Money  based 
on  specie  not  ideal,  but  the  best  available,  442  —  Sec.  10.  In  what 
sense  the  term  "  money  "  is  best  used,  444. 

REFERENCES  ON  BOOK  III 445-446 

BOOK  IV 
INTERNATIONAL    TRADE 

CHAPTER  32 

THE  FOREIGN  EXCHANGES »        -*        .         .      449-467 

Section  1.  The  "foreign  exchanges,"  based  on  the  varying  coin- 
age systems  of  different  countries.  How  bills  of  exchange  settle 
payments  without  the  movement  of  specie,  449  —  Sec.  2.  The  par 
of  exchange,  and  premium  and  discount  of  exchange ;  illustrated 
by  sterling  exchange  in  New  York,  451  —  Sec.  3.  Bankers  as 
middlemen  in  foreign  exchange.  Fluctuations  in  rates,  due  to  the 
higgling  of  the  market,  453  —  Sec.  4.  Dealings  between  a  series  of 
countries,  illustrated  by  transactions  between  the  United  States, 
England,  and  Brazil,  456  —  Sec.  6.  In  what  manner  prices  are 
influenced  :  in  the  long  run,  by  the  flow  of  specie  ;  for  shorter 
periods,  by  the  rates  of  discount.  Various  complicating  factors, 
458  —  Sec.  6.  Foreign  exchange  between  gold-standard  and  silver- 
standard  countries.  The  case  of  British  India  until  1893,  462  — 
Sec.  7.  Foreign  exchange  when  there  is  depreciated  paper.  Rela- 
tion between  imports  and  exports,  general  prices,  and  specie  pre- 
mium, 464  —  Sec.  8.  "  Domestic  exchange  "  in  the  United  States  ; 
in  times  past  an  important  matter,  now  reduced  within  very  slight 
range  of  fluctuation,  466. 

CHAPTER  33 

THE  BALANCE  OF  INTERNATIONAL  PAYMENTS        .         .        .        .      468-478 

Section  1.  Other  items  than  merchandise  exports  and  imports. 
Lending  and  borrowing  and  their  effects  on  exports  and  imports. 
International  dealings  in  securities,  468  —  Sec.  2.  Expenses  of  trav- 
elers and  nonresidents.  Remittances  from  the  United  States  by 


xxii  CONTENTS 

TOL.  . 
PAGES 

immigrants.  Freight  charges,  472  —  Sec.  3.  Position  of  a  country 
that  mines  specie,  473  —  Sec.  4.  Illustration  from  the  international 
trade  of  the  United  States,  1790-1908,  476  — Sec.  5.  The  notion  of 
a  favorable  and  unfavorable  balance  of  trade.  Usual  attitude  of 
the  business  community.  In  the  main,  an  excess  of  imports  or  of 
exports  is  no  indication  of  loss  or  gain ;  least  of  all,  in  the  trade 
between  one  country  and  any  other  country,  476. 

CHAPTER  34 

THE  THEORY  OF  INTERNATIONAL  TRADE.    WHY  GOODS  ARE  EXPORTED 

AND  IMPORTED          .........      480-493 

Section  1.  Some  familiar  facts :  money  incomes  and  prices  differ 
in  different  countries ;  but  prices  of  goods  entering  into  interna- 
tional trade  tend  to  be  the  same.  Money  wages  not  necessarily 
low  in  exporting  countries,  480  —  Sec.  2.  A  country  exports  those 
things  in  which  its  labor  is  relatively  efficient,  —  in  which  it  has  a 
comparative  advantage.  Illustrations  from  countries  of  high  wages 
and  of  low  wages,  482  —  Sec.  3.  Specially  low  wages  of  a  particular 
class  of  laborers  operate  as  a  comparative  advantage.  General  low 
wages  do  not  affect  international  trade  or  enable  universal  under- 
selling, 485  —  Sec.  4.  A  country  may  import  things  for  which  its 
labor  is  productive,  if  its  labor  is  even  more  productive  for  other 
things.  But  international  trade  rests  largely  on  absolute  differences 
in  cost,  488  —  Sec.  5.  The  gain  from  differences  in  comparative  cost 
is  dependent  on  immobility  of  labor  between  countries,  490  — 
Sec.  6.  A  country  may  import  part  of  the  supply  of  a  given  com- 
modity, produce  a  part  at  home.  Difference  between  extractive 
and  manufacturing  industries  in  this  regard,  491 

CHAPTER  35 

THE  THEORY  OF  INTERNATIONAL  TRADE  (continued) .     WHEREIN  THE 

GAIN  CONSISTS 494-507 

Section  1.  Difference  between  exchange  within  a  country  and 
international  exchange.  Varying  rates  of  wages  in  different  coun- 
tries show  varying  gain  from  the  exchanges  between  them,  494  — 
Sec.  2.  An  illustrative  case,  England  and  Italy.  Demand  and 
utility  determine  relative  wages  and  prices.  Slow  and  obscured 
operation  of  this  cause,  through  the  influence  of  the  specie  supply 
on  prices,  495  —  Sec.  3.  Effects  of  changes  in  international  demand ; 
of  new  articles  of  export ;  of  payments  other  than  for  merchandise, 
498  —  Sec.  4.  Difficulty  of  following  these  causes  in  detail,  illus- 
trated by  the  case  of  the  United  States  since  1873,  499  —  Sec.  5. 
Money  incomes,  not  prices,  important  in  determining  the  gain  from 
international  trade,  501  —  Sec.  6.  Two  causes  act  on  the  gain  :  the 


CONTENTS  xxiii 

VOL.  I 

FAWM 

play  of  international  demand  and  the  efficiency  of  labor  in  produc- 
ing exported  goods.  The  last  cause  settles  the  general  rate  of 
money  wages,  603  —  Sec.  7.  High  money  wages  and  other  incomes 
do  not  necessarily  bring  high  domestic  prices.  Illustration  from 
the  United  States,  604. 

CHAPTER   36 

PROTECTION  AND  FREE  TRADE.     THE  CASE  FOR  FREE  TRADE    .      508-523 

Section  1.  The  main  argument  for  free  trade  is  simple.  Persist- 
ence of  mercantilist  notions,  608  —  Sec.  2.  Some  popular  arguments 
for  protection :  creating  a  home  market ;  the  truck-farm  case ; 
creating  employment,  610  —  Sec.  3.  The  effect  of  protection  on 
wages.  General  wages  lowered,  though  some  particular  wages  pos- 
sibly kept  up,  513  —  Sec.  4.  The  principle  of  equalizing  cost  of 
production,  616  —  Sec.  5.  Effects  of  duties  on  prices  and  on  con- 
sumers. A  national  loss  only  if  domestic  products  are  substituted 
for  those  imported.  Monopoly  may  bring  special  gain  to  domestic 
capitalists,  but  brings  no  national  loss.  Labor  monopoly  may  bring 
special  gains  to  particular  laborers,  618. 

CHAPTER  37 

PROTECTION  AND  FREE  TRADE.  SOME  ARGUMENTS  FOR  PROTECTION     524-546 

Section  1.  Protective  duties,  by  their  effects  on  general  money 
incomes,  may  bring  more  advantageous  terms  of  international  ex- 
change, 524  —  Sec.  2.  Protection  to  young  industries.  Applicable 
hi  the  main  to  manufactures  only.  Difficulty  of  gauging  its  success 
in  specific  cases,  526  —  Sec.  3.  Political  considerations,  illustrated 
by  the  case  of  shipping  subsidies,  530  —  Sec.  4.  Social  considers 
tions  may  tell  against  manufactures,  but  not  necessarily  so.  The 
contemporary  controversy  in  Germany ;  Agrarstaat  vs.  Industrie- 
staat.  The  argument  as  to  the  failure  of  food  supplies,  533 — Sec.  5. 
Peculiar  dependence  of  England  on  international  trade  and  on  ex- 
ports. Possibility  of  strengthening  her  position  as  exporter  by 
agreements  with  colonies  and  by  threats  of  retaliation,  636  —  Sec.  6. 
Growth  of  protection  during  the  last  generation,  538  —  Sec.  7. 
Economic  effects  of  protection  in  the  United  States  ;  impossible  to 
measure  with  accuracy,  but  certainly  exaggerated  in  popular  dis- 
cussion, 640  —  Sec.  8.  Conditions  under  which  manufactures  would 
maintain  themselves  without  protection.  Effect  of  machinery  in 
connection  with  comparative  costs,  542  — Sec.  9.  Concluding 
remarks  on  the  working  of  protection  in  the  United  States,  545. 

REFERENCES  ON  BOOK  IV  646-547 


xxiv  CONTENTS 


VOLUME  II 

BOOK  V 
THE  DISTRIBUTION  OF  WEALTH 

CHAPTER   38  VOL.  n 

PAGES 

INTEREST   ON  CAPITAL   USED  IN  PRODUCTION.      THE   CONDITIONS  OF 

DEUAND    ...........  8-15 

Section  1.  What  is  meant  by  distribution,  3  —  Sec.  2.  The 
essential  problem  as  to  interest.  Money  is  not  the  cause  of  inter- 
est, nor  does  its  quantity  affect  the  rate  of  interest,  4  —  Sec.  3. 
Why  there  is  a  demand  for  present  means ;  the  effectiveness  of  the 
time-using  processes  of  production.  Is  capital  productive  ?  5  — 
Sec.  4.  How  the  marginal  effectiveness  or  productivity  of  capital 
determines  the  rate  of  return.  A  consumer's  surplus  arises  from 
the  more  effective  applications.  Analogy  to  the  problems  of  value 
and  utility,  8  —  Sec.  5.  Is  there  a  general  tendency  to  diminish- 
ing returns  from  successive  doses  of  capital  ?  11. 

CHAPTER   39 

INTEREST  (continued).    THE  EQUILIBRIUM  OF  DEMAND  AND  SUPPLY       16-28 

Section  1.  Accumulation  of  present  means  needs  an  inducement, 
16  —  Sec.  2.  The  gradations  in  the  disposition  to  save.  Cases 
where  the  inducement  needs  to  be  slight,  16  —  Sec.  3.  Cases  where 
a  return  is  sought.  Possibility  that  a  lowered  return  will  sometimes 
induce  larger  savings.  More  often,  lowered  return  checks  saving. 
The  conception  of  marginal  savers,  19  —  Sec.  4.  Diagrams  express- 
ing the  equilibrium  of  supply  and  demand.  Savers'  surplus,  22  — 
Sec.  5.  The  steadiness  of  the  rate  of  interest  in  modern  times  and 
its  significance,  26  —  Sec.  6.  The  race  between  accumulation  and 
improvement,  27. 

CHAPTER  40 
INTEREST,  FURTHER  CONSIDERED    .        .  .        .        .        .         29-43 

Section  1.  Loans  for  consumption  introduce  no  new  principle  as 
to  demand,  but  are  much  affected  by  the  absence  of  full  competition, 
29  —  Sec.  2.  Public  borrowing  for  wars  an  important  form  of  such 
loans  in  modern  times,  32 — Sec.  3.  Durable  consumer's  goods,  as 
a  form  of  investment,  again  introduce  no  new  principle,  32  —  Sec. 
4.  No  grounds  for  distinguishing  between  producer's  capital  and 
consumer's  capital,  so  far  as  interest  is  concerned.  Exchange  of 
present  for  future  the  most  general  statement  of  the  cause  of  inter- 
est, 35  —  Sec.  5.  The  mechanism  of  banking  and  credit  makes 
interest  all-pervasive,  37  —  Sec.  6.  Variations  in  the  rate  of  in- 


CONTENTS  xxv 

VOL.  II 
PA4HB 

terest  in  different  countries  and  for  different  investments,  38  — 
Sec.  7.  The  justification  and  social  significance  of  interest,  41. 

CHAPTER  41 

OVERPKODUCTION   AND'  OVERINVESTMENT  .  *    :       .  .  .  44-54 

Section  1.  Overproduction  in  the  sense  of  excess  beyond  the 
possibility  of  use,  is  impossible.  The  extensibility  of  wants,  44  — 
Sec.  2.  Overproduction,  in  the  sense  of  production  beyond  the 
stage  of  profit,  is  possible  if  investment  proceeds  unendingly.  The 
process  of  advances  to  laborers  and  the  readjustment  of  production 
under  the  supposed  conditions.  Check  to  the  extreme  result,  from 
the  cessation  of  accumulation.  The  reasoning  of  Rodbertus  criti- 
cized, 45  —  Sec.  3.  A  real  tendency  to  overproduction,  through 
overinvestment  in  the  familiar  industries,  60  —  Sec.  4.  Industries 
with  large  plant,  best  managed  under  continuity  of  operation,  are 
tempted  to  overproduction  or  else  to  combination,  52  —  Sec.  5. 
The  phenomena  of  crises  and  industrial  depression  are  in  reality 
different  from  those  of  overproduction,  53. 

CHAPTER  42 

RENT,  AGRICULTURE,  LAND  TENURE     ......          55-75 

Section  1.  The  theory  of  surplus  produce  or  "rent."  Rent  does 
not  enter  into  the  price-determining  expenses  of  production.  Rent 
is  not  the  specific  product  of  land,  55  —  Sec.  2.  The  existence  of 
rent  is  dependent  upon  diminishing  returns  from  land.  Advantages 
of  situation  as  affecting  rent,  58  —  Sec.  3.  Qualifications  of  the 
principle  of  diminishing  returns :  a  possible  stage  of  increasing  re- 
turns ;  specific  plots  alone  to  be  considered  ;  a  given  stage  of  agri- 
cultural skill  assumed,  61  —  Sec.  4.  The  stage  when  the  tendency 
to  diminishing  returns  is  sharp,  64 — Sec.  5.  Are  there  original 
and  indestructible  powers  of  the  soil  ?  Predatory  cultivation ;  inten- 
sive and  extensive  agriculture.  Inherent  differences  tend  to  be 
lessened,  but  do  not  disappear,  65  —  Sec.  6.  Land  tenure.  Culti- 
vation by  owners,  each  with  moderate  holdings,  of  greatest  social 
advantage,  70  —  Sec.  7.  Should  the  community  appropriate  or 
retain  for  itself  agricultural  rent  ?  72. 

CHAPTER  43 

03BAN  SITB  RBNT 78-91 

Section  1.  How  rent  arises  on  sites  for  retail  trading,  wholesale 
trading,  manufactures,  dwellings,  76  —  Sec.  2.  The  principle  of 
diminishing  returns  on  urban  sites ;  its  operation  less  steep  than 
for  agricultural  land,  80  —  Sec.  3.  Site  rent  depends  upon  shrewd- 


xxvi  CONTENTS 

VOL.  It 
PAGM 

ness  in  utilization.  The  activity  of  real  estate  speculators,  83  — 
Sec.  4.  When  capital  is  sunk  irrevocably  in  the  soil,  there  is  diffi- 
culty in  separating  rent  from  return  on  capital.  How  far  ground 
rent  is  identical  with  economic  rent,  84  —  Sec.  6.  How  far  the 
activity  of  real  estate  dealers  and  speculators  is  productive,  87  — 
Sec.  6.  Urban  rent  is  sometimes  deliberately  created ;  is  it  then 
economic  rent  ?  89. 

CHAPTER  44 

RENT  (concluded) 92-106 

Section  1.  The  rent  of  mines,  how  influenced  by  risk.  Dimin- 
ishing returns  on  mines,  92  —  Sec.  2.  Are  mining  royalties  rent  ? 
96 —  Sec.  3.  The  selling  price  of  a  site  is  a  capitalization  of  its 
rent,  97  —  Sec.  4.  The  problem  of  appropriating  rent  for  the  pub- 
lic is  presented  most  sharply  by  urban  sites.  The  possibility  of 
leases  on  long  term  by  the  state ;  the  historical  development  of 
unqualified  private  ownership  and  of  vested  rights,  98  —  Sec.  6. 
The  future  increase  of  rent  a  proper  object  of  taxation.  Modes 
of  levying  such  taxes,  102. 


CHAPTER  45 

MONOPOLY  GAINS 107-114 

Section  1.  Absolute  monopolies  ;  industrial  monopolies.  Patents 
and  copyrights  as  instances  of  absolute  monopolies ;  the  grounds 
for  creating  them  by  law,  107  —  Sec.  2.  "  Public  service  "  monopo- 
lies. Increasing  returns  and  increasing  profits,  110 —  Sec.  3.  Com- 
binations and  "  Trusts  "  ;  the  uncertainty  as  to  the  extent  of  their 
monopoly  power,  112  —  Sec.  4.  The  capitalization  of  monopoly 
gains  and  the  problems  as  to  vested  rights,  113. 


CHAPTER  46 

THE  NATUEB  AND  DEFINITION  OF  CAPITAL 115-123 

Section  1.  Is  the  distinction  between  interest  and  rent  tenable, 
in  view  of  the  wide  extent  of  differential  gains  of  a  monopoly  sort  ? 
Grounds  for  maintaining  that  all  returns  from  property  of  any  kind 
are  homogeneous,  115  —  Sec.  2.  A  different  conception  of  "rent" 
and  "  interest,"  the  two  being  regarded  as  different  ways  of  stating 
the  same  sort  of  income.  "Artificial"  and  "natural"  capital. 
How  measure  the  amount  of  capital  ?  117  —  Sec.  3.  The  important 
questions  are  on  the  effectiveness  of  competition,  the  existence  of 
a  normal  rate  of  interest,  the  justification  of  interest,  120. 


CONTENTS  xxvii 

CHAPTER   47  TOL.II 

PAGES 

DIFFERENCES  OP  WAGES.     SOCIAL  STRATIFICATION       .        .         .      124-146 

Section  1.  Differences  of  wages  which  serve  to  equalize  attractive- 
ness of  different  occupations ;  domestic  servants,  university  teachers, 
public  employees,  124  —  Sec.  2.  Irregularity  of  employment  and 
risk  in  their  effect  on  relative  wages.  Expense  of  training,  126  — 
Sec.  3.  Obstacles  to  free  movement  bring  about  real  differences. 
Full  monopoly  rare,  127  — Sec.  4.  Expense  of  education  as  an 
obstacle  to  mobility,  129 — Sec.  5.  Inequalities  of  inborn  gifts  and 
social  stratification.  Uncertainty  of  our  knowledge  concerning 
the  influence  of  inborn  gifts,  130 — Sec.  6.  Noncompeting  groups, 
roughly  analyzed  as  five.  The  broad  division  between  soft-handed 
and  hard-handed  occupations,  134 — Sec.  7.  Tendency  to  greater 
mobility  in  modern  times.  The  position  of  common  laborers,  138 
—  Sec.  8.  What  differences  in  wages  would  persist  if  all  choice 
were  free,  141  —  Sec.  9.  Why  the  wages  of  women  are  low,  and 
wherein  the  labor  of  women  is  socially  advantageous,  142. 

CHAPTER  48 

WAGBS  AND  VALUE 147-157 

Section  1.  "  Expenses  of  production  "  and  "  cost  of  production  " 
again  considered.  If  there  were  perfect  freedom  of  choice  among 
laborers,  value  would  be  governed  by  cost,  147  —  Sec.  2.  There 
being  noncompeting  groups,  demand  (marginal  utility)  governs 
relative  wages.  How  this  principle  applies  to  a  grade  or  group ; 
marginal  indispensability,  148  —  Sec.  3.  Qualifications :  earnings 
may  be  so  divergent  as  to  cause  seepage  from  one  group  into 
another  ;  the  standard  of  living  may  affect  numbers  within  a  group, 
162  —  Sec.  4.  The  lines  of  social  stratification  are  stable;  hence 
changes  from  the  existing  adjustments  of  value  are  not  usually 
affected  by  them,  153  —  Sec.  5.  The  theory  of  international  trade 
brought  into  harmony  with  the  theory  of  value  under  noncompeting 
groups,  154  —  Sec.  6.  Analogies  between  international  trade  and 
domestic  trade,  156. 

CHAPTER  49 
BUSINESS  PROFITS   .        .        .        .        ...        .        .        .      158-171 

Section  1.  Business  profits  rest  on  the  assumption  of  risks,  158  — 
Sec.  2.  Position  of  the  business  man  as  receiver  of  a  residual  in- 
come. Irregularity  and  wide  range  of  this  income,  its  relation  to 
prices.  Though  irregular,  it  is  not  due  to  chance,  159  —  Sec.  3.  The 
part  played  by  inborn  ability  ;  that  played  by  opportunity,  environ- 
ment, training,  161  —  Sec.  4.  The  qualities  requisite  for  success : 
imagination,  judgment,  courage.  Mechanical  talent  not  so  iiupor- 


xxviii  CONTENTS 

vox.,  n 

PAGES 

tant  as  might  be  expected.  Relations  of  the  business  man  to 
inventors.  Diversity  of  qualities  among  the  successful,  163  — 
Sec.  6.  A  process  of  natural  selection  among  business  men.  Natu- 
ral capacity  tells  more  than  in  most  occupations,  166  —  Sec.  6. 
Motives  of  business  activity  and  money-making.  Social  ambition 
the  main  impulse ;  other  motives  are  also  at  work,  167  —  Sec.  7. 
What  changes  would  occur  if  business  ability  were  very  plentiful 
and  capacity  for  muscular  labor  very  scarce,  170. 

CHAPTER   50 

BUSINESS  PROFITS  (continued) 172-191 

Section  1.  Analogy  between  business  profits  and  rent.  A  similar 
analogy  in  other  occupations.  How  far  the  element  of  risk  vitiates 
the  analogy,  172  —  Sec.  2.  The  difference  in  business  abilities  ex- 
plains differences  in  cost  of  production.  The  conception  of  the 
"representative  firm"  as  settling  normal  expenses  of  production, 
175  —  Sec.  3.  One  of  the  manifestations  of  business  ability  is  in  the 
selection  of  good  natural  resources.  In  the  end,  an  important 
difference  between  economic  rent  and  differential  business  profits, 
177  —  Sec.  4.  The  connection  between  the  return  on  capital  and 
business  profits.  Relations  between  owners  and  managers  of  capi- 
tal at  different  times.  Modern  tendency  toward  a  separation  of 
functions  and  rewards,  179  —  Sec.  5.  For  considerable  periods, 
command  of  capital  brings  in  a  given  enterprise  the  probability  of 
larger  profits  ;  but  not  in  the  long  run  without  business  ability,  181 
—  Sec.  6.  For  industry  as  a  whole  and  capital  as  a  whole,  there  is 
a  connection  for  considerable  periods  between  interest  and  business 
profits.  How  they  may  diverge  in  the  end,  183  —  Sec.  7.  A  view 
of  business  profits  which  distinguishes  them  sharply  from  wages, 
as  arising  solely  in  a  dynamic  state,  184  —  Sec.  8.  Another  view, 
which  lays  emphasis  on  risk,  and  distinguishes  between  the  wages 
of  salaried  managers  and  the  "profits"  of  independent  business 
men.  The  salaried  manager  often  rewarded  de  facto  in  proportion 
to  "profits,"  185  —  Sec.  9.  Legitimate  and  illegitimate  business 
profits.  Their  restriction  within  the  legitimate  limits  dependent 
on  the  removal  of  monopoly  gains  and  the  maintenance  of  a  high 
plane  of  competition,  187. 

CHAPTER   51 

GENERAL  WAGES 192-B08 

Section  1.  The  fundamental  question  as  to  general  wages  is  raised 
by  the  case  of  hired  laborers,  192  —  Sec.  2.  The  notion  that  lavish 
expenditure  creates  demand  for  labor  and  makes  wages  high.  Con- 
sequences of  investment  as  compared  with  "expenditure,"  192  — 
Sec.  3.  The  fallacy  of  "making  work."  Why  hired  laborers  uni- 


CONTENTS  xxix 

VOL.  II 
PAGK8 

versally  desire  that  employment  should  be  created  and  dislike 
labor-saving  appliances,  194  —  Sec.  4.  The  theory  of  the  specific 
product  of  labor  as  determining  wages,  197  —  Sec.  6.  Wages  depend 
on  the  discounted  marginal  product  of  labor.  Explanation  of 
"margin"  and  of  "discount."  Advances  to  laborers,  198  — 
Sec.  6.  Some  qualifications.  (1)  The  current  rate  of  interest  is 
assumed  to  be  settled  by  time  preference ;  otherwise  there  is  reason- 
ing in  a  circle.  (2)  A  broad  competitive  margin  is  assumed, 
otherwise  there  is  no  settlement  either  of  interest  or  of  wages,  200 
—  Sec.  7.  The  mechanism  of  advances  to  laborers,  the  flow  of  real 
income  into  their  hands,  the  reservoir  of  existing  supplies,  the 
replacement  of  what  is  advanced,  203  —  Sec.  8.  With  the  increas- 
ing complexity  of  production,  interest  tends  to  be  a  larger  part, 
wages  a  smaller  part,  of  the  total  income  of  society,  205  —  Sec.  9. 
The  theory  of  general  wages,  though  it  seems  remote  from  the  prob- 
lems of  real  life,  is  of  high  importance  for  the  great  social  ques- 
tions, 207. 

CHAPTER   52 

POPULATION     .        .        .        .•..-.«        .        .        .        .        .      209-225 

Section  1.  The  Malthusian  theory,  how  far  strengthened  by  bio- 
logical science,  209  —  Sec.  2.  The  maximum  birth  rate,  the  minimum 
death  rate,  the  consequent  possibilities  of  multiplication.  In  what 
sense  there  is  a  tendency  to  rapid  multiplication  ;  the  positive  and 
preventive  checks,  210  —  Sec.  3.  The  actual  birth  rates  and  death 
rates  of  some  countries  in  modern  times.  A  high  birth  rate 
ordinarily  entails  a  high  death  rate.  Explanation  of  exceptions. 
The  situation  in  the  United  States,  214  —  Sec.  4.  Does  a  high  birth 
rate  cause  low  wages,  or  vice  versa  f  Interaction  of  causes.  A 
limitation  of  numbers  not  a  cause,  but  a  condition,  of  general  pros- 
perity and  high  wages,  220  —  Sec.  5.  The  standard  of  living  affects 
wages,  not  directly,  but  through  its  influence  on  numbers.  Fallacies 
on  this  subject,  221  —  Sec.  6.  Mode  in  which  the  modern  decline  in 
the  birth  rate  has  taken  place,  223. 

CHAPTER  53 

POPULATION  (continued) •-•  226-237 

Section  1.  Differences  between  social  strata  in  birth  rates,  and 
their  relation  to  varying  standards  of  living,  226  —  Sec.  2.  The 
main  cause  of  the  general  tendency  to  lower  birth  rate  is  social 
ambition.  Its  connection  with  private  property  and  individualism. 
Illustration  from  native-born  and  immigrants  in  the  United  States, 
230  —  Sec.  3.  Is  the  preventive  check  being  carried  too  far  ?  Eugen- 
ics and  race  suicide,  234. 


xxx  CONTENTS 


CHAPTER  64  TOL.  M 

PASES 

INEQUALITY  AND  rrs  CAUSES 238-256 

Section  1.  The  fact  of  inequality :  distribution  has  a  roughly 
pyramidal  form.  Figures  indicating  the  distribution  of  income 
for  Prussia,  for  Great  Britain,  for  London,  238  —  Sec.  2.  The  dis- 
tribution of  property,  as  indicated  by  probates  in  Great  Britain, 
by  tax  statistics  in  Prussia,  242  —  Sec.  3.  How  far  it  appears  that 
inequality  is  becoming  greater.  Dearth  of  information  regarding 
distribution  in  the  United  States,  245  —  Sec.  4.  The  causes  of 
inequality  :  differences  in  inborn  gifts  ;  the  maintenance  of  ac- 
quired advantages,  through  opportunity  and,  above  all,  through 
inheritance,  246  —  Sec.  5.  Inheritance  to  be  justified  as  essential 
for  the  maintenance  of  capital  under  a  system  of  private  property. 
Possible  limitations  of  inheritance,  through  taxation  and  in  other 
ways,  248  —  Sec.  6.  The  grounds  on  which  private  property  rests. 
The  utilitarian  reasoning :  differences  in  inborn  gifts,  accumu- 
lation, inheritance.  The  leisure  class ;  its  economic  and  moral 
position,  251  —  Sec.  7.  Whatever  the  eventual  changes,  private 
property,  inequality,  and  the  leisure  class,  will  long  endure,  255. 

REFERENCES  ON  BOOK  V  257 


BOOK  VI 

PROBLEMS   OF  LABOR 
CHAPTER  55 

TRADE-UNIONS 261-284 

Section  1.  Introductory.  Character  of  the  questions  in  this  book  : 
they  involve  the  weighing  of  conflicting  considerations,  and  are 
affected  by  social  sympathy,  261  —  Sec.  2.  Bargaining  power  of 
laborers  strengthened  by  unions.  Weakness  of  the  single  laborer. 
Immobility  of  labor ;  lack  of  reserve  funds  ;  perishability,  262  — 
Sec.  3.  Monopolistic  tendencies  of  trade-unions  of  skilled  workers  ; 
not  often  of  permanent  importance.  The  open  union,  such  as  alone 
can  develop  among  the  less  skilled,  a  potent  instrument  for  good, 
266  —  Sec.  4.  Closed  shop  or  open  shop  ?  A  strong  case  prima 
facie  for  the  closed  shop  with  the  open  union,  269  —  Sec.  6.  The 
danger  of  a  check  to  progress  and  efficiency  under  the  closed  shop. 
Limitation  of  output ;  piece  work ;  the  standard  rate  ;  labor-saving 
appliances  ;  discipline,  271  —  Sec.  6.  A  division  between  open  shop 
and  closed  shop  not  unacceptable.  Grounds  of  employers'  opposition 
often  untenable,  276  —  Sec.  7.  The  scab  and  the  use  of  violence. 
The  tie-up,  279  —  Sec.  8.  The  unionist  movement  likely  to  extend, 
and  entitled  to  sympathy,  282. 


CONTENTS  xxxi 


CHAPTER   56  vox.,  n 

PAOEA 

LABOR  LEGISLATION 285-302 

Section  1.  Labor  legislation,  like  labor  organization,  aims  to 
standardize  conditions  of  employment.  Legislation  on  the  hours 
of  labor  for  women  and  children  the  typical  case.  Other  sorts  of 
restriction.  Situation  in  the  United  States,  285  —  Sec.  2.  Why 
legislation  must  supplement  and  support  the  laborers'  own  efforts. 
A  great  moving  force  behind  it  is  the  growth  of  altruism,  289  — 
Sec.  3.  Limitation  of  hours  for  men  comparatively  rare.  Are  there 
grounds  on  principle  for  confining  such  legislation  to  women  and 
children  ?  Constitutional  questions  in  the  United  States,  291  — 
Sec.  4.  The  demand  for  an  eight-hour  day  deserves  support.  Intro- 
duced suddenly  and  universally,  the  eight-hour  day  would  mean  a 
decline  in  product  and  in  wages ;  introduced  gradually,  and  pari 
passu  with  improvements  in  production,  it  brings  unmixed  gain, 
293  —  Sec.  5.  Minimum  wages  introduce  no  new  principle,  but 
present  the  problem  how  to  deal  with  the  unemployable,  297. 


CHAPTER   67 

SOME  AGENCIES  FOR  INDUSTRIAL  PEACE 303-322 

Section  1.  Profit  sharing  affects  profits  as  the  residual  element. 
Some  modes  of  applying  it.  Immediate  and  deferred  participation, 
303  —  Sec.  2.  Profit  sharing  will  not  be  widely  applied  unless  it 
pays,  by  increasing  efficiency.  Uncertain  connection  between 
profits  and  workmen's  efficiency.  Importance  of  the  employer's 
personality,  306  —  Sec.  3.  Other  methods  of  linking  employee  to 
employer:  "  gainsharing "  and  "welfare"  arrangements,  309  — 
Sec.  4.  The  sliding  scale,  applicable  where  product  is  homogeneous. 
Not  in  harmony  with  the  general  principle  of  employer's  assumption 
of  industrial  risks,  yet  often  helpful  toward  avoiding  friction  and 
dispute,  311  —  Sec.  5.  Arbitration,  private  and  public.  Not  appli- 
cable where  such  matters  as  recognition  of  union  or  the  closed  shop 
are  in  dispute  ;  but  applicable  to  questions  of  wages  and  the  like. 
Private  boards  imply  trade  agreements  and  organized  unions. 
Public  boards  are  usually  boards  of  conciliation,  but  none  the  less 
helpful,  313  —  Sec.  6.  Compulsory  arbitration,  carried  to  its  logical 
outcome,  means  settlement  of  all  distribution  by  public  authority, 
and  may  be  the  entering  wedge  to  socialism.  Possibility  that  it 
will  remain  indefinitely  in  a  halfway  stage  and  not  proceed  to  this 
outcome,  316  —  Sec.  7.  Compulsory  arbitration  in  the  limited  range 
of  "public  service"  industries  presents  no  such  deep- reaching 
questions,  and  ought  to  be  applied,  320. 


xxxii  CONTENTS 

CHAPTER  68  V0i,.n 

PAGES 

WORKMEN'S  INSURANCE.     POOR  LAWS 323-345 

Section  1.  Irregularity  of  earnings  and  its  causes,  323  —  Sec.  2. 
Provision  against  accident  is  feasible  through  insurance.  The 
German  system,  the  English,  the  French.  The  charges,  though 
levied  on  the  employer,  are  likely  to  come  ultimately  out  of  wages, 
323  —  Sec.  3.  Insurance  against  sickness  no  less  feasible.  The 
Friendly  Societies,  the  German  system  of  compulsory  insurance. 
The  possibility  of  malingering  and  the  need  of  supervision,  328  — 
Sec.  4.  Old-age  pensions  in  European  countries  and  in  Australia. 
Are  they  deterrents  to  thrift  ?  The  pecuniary  difficulties  not  in- 
superable, 331  —  Sec.  5.  The  situation  in  the  United  States  as  to  ac- 
cidents long  chaotic ;  the  need  of  reform.  Rapid  spread  of  compen- 
sation for  accident.  The  political  difficulties  in  the  way  of  this 
reform  and  others,  334  —  Sec.  6.  Unemployment,  though  it  tends  to 
correct  itself,  is  a  continuing  phenomenon.  Difficulties  of  applying 
any  method  of  insurance.  Possibility  of  supplementing  trade-union 
out-of-work  benefits.  The  British  National  Insurance  act  of  1911. 
Relief  works,  337  —  Sec.  7.  Poor  laws  :  the  conflict  between  sym- 
pathy and  caution.  Relief  may  be  liberal  where  no  danger  of 
demoralization  exists.  For  the  able-bodied,  it  needs  to  be  admin- 
istered with  the  utmost  caution,  342. 

CHAPTER  69 

COOPERATION 346-369 

Section  1.  Cooperation  attempts  to  dispense  with  the  business 
man.  Its  various  forms,  346  —  Sec.  2.  Cooperation  in  retail  trad- 
ing, when  done  by  the  well-to-do,  of  no  social  significance.  When 
done  by  workingmen,  as  in  Great  Britain,  it  has  larger  effects. 
Methods  of  the  workingmen's  stores  and  causes  of  their  success. 
The  movement  elsewhere,  347  —  Sec.  3.  Credit  cooperation  in  Ger- 
many ;  its  methods  and  results.  Other  sorts  of  societies,  and 
development  in  other  countries,  352  —  Sec.  4.  Cooperation  in  pro- 
duction would  most  affect  the  social  structure,  but  has  had  the 
least  development.  Causes  of  failure  ;  the  rarity  of  the  business 
qualities,  and  the  limitations  of  workingmen.  The  future  of  co- 
operation, 355. 

REFERENCES  ON  BOOK  VI  859-360 


RAILWAY  PROBLEMS        .         .         .        ...        .        .         .      363-381 

Section  1 .  Railways  an  instrument  for  furthering  the  geographical 
division  of  labor.     Corollary  from  this  that  they  are  not  to  the 


CONTENTS  xxxiii 


public  interest  unless  they  pay,  363  —  Sec.  2.  Economic  character- 
istics of  railways  ;  first,  the  great  plant.  Consequent  tendency  to 
decreasing  cost.  Hence  also  frequency  of  rapid  transition  from 
financial  failure  to  financial  success,  366  —  Sec.  3.  Second,  the  ele- 
ment of  joint  cost,  both  as  to  fixed  charges  and  operating  expenses. 
Charging  what  the  traffic  will  bear ;  classification  of  freight,  369  — 
Sec.  4.  Justification  of  charging  what  the  traffic  will  bear  lies  in 
full  utilization  of  the  railway  equipment,  372  —  Sec.  6.  The  pecul- 
iar severity  of  railway  competition  explained  by  joint  cost.  How 
far  lower  competitive  rates  on  long  hauls  are  justified,  373  —  Sec.  6. 
Other  consequences  of  joint  cost :  flexibility  of  rates,  and  difficulty 
of  deciding  what  is  a  reasonable  rate,  375  —  Sec.  7.  Chaotic  rates 
in  the  United  States,  and  concession  to  favored  shippers,  partly 
corrupt,  partly  the  result  of  competition,  376  —  Sec.  8.  "  Rebates" 
and  the  grounds  for  prohibiting  them.  Rate  agreements  and  pools 
as  aids  in  preventing  discriminations.  Inconsistency  of  our  legisla- 
tion on  rebates  and  rate  agreements,  379. 

CHAPTER  61 

RAILWAY  PROBLEMS  (continued)    .        .  .        .        .        .      382-396 

Section  1.  Effects  of  railways  on  distribution.  An  unearned 
increment  analogous  to  rising  rent  of  land,  382  —  Sec.  2.  Tendency 
toward  concentration  of  ownership ;  how  promoted  by  American 
methods  of  corporate  organization.  Overcapitalization  and  its  con- 
sequences, 384  —  Sec.  3.  Stock  speculation,  stimulated  by  over- 
capitalization, has  facilitated  acquisition  of  control  by  the  "great 
operators,"  388  —  Sec.  4.  "Inside  management"  and  its  evils,  390 

—  Sec.  5.  What  benefits  have  come  from  private  ownership  in  the 
United  States,  and  how  far  railway  fortunes  have  been  earned,  391 

—  Sec.  6.   Increasing  tendency  to  monopoly,  and  need  of  public 
control  over  rates,  394. 

CHAPTER  62 

PUBLIC  OWNERSHIP  AND  PUBLIC  CONTROL    ...  .     S97-418 

Section  1.  What  are  "public  service"  industries?  The  legal 
conception  less  important  than  the  economic  ;  the  essential  earmark 
is  monopoly,  397  —  Sec.  2.  The  spur  of  profit  necessary  for  im- 
provements in  the  arts ;  hence  a  preliminary  stage  of  private 
ownership  is  inevitable,  401  — Sec.  3.  The  question  of  vested  rights 
when  public  ownership  displaces  private.  "Franchises"  should 
always  be  for  limited  terms.  Purchase  at  market  value,  403  — 
Sec.  4.  Are  there  criteria  marking  some  industries  as  suitable  for 
public  management  ?  The  tests  suggested  by  Jevons  ;  distrust  of 
public  officials  underlies  them  all,  405  —  Sec.  5.  To  secure  trust- 


xxxiv  CONTENTS 

VOL.  a 

PAQBB 

worthy  and  efficient  public  officials  is  partly  a  problem  of  political 
machinery.  Some  difficulties  of  public  management,  as  regards 
the  employment  of  labor  and  the  maintenance  of  progress,  407  — 
Sec.  6.  The  fundamental  requisite  in  a  democracy  is  a  generally 
high  level  of  character  and  intelligence.  In  what  way  corruption 
is  connected  with  monopoly  industries,  409  —  Sec.  7.  The  future 
of  democracy  depends  on  its  success  in  dealing  with  these  indus- 
tries. Experiments  in  ownership  to  be  welcomed,  especially  in 
municipalities.  The  prejudices  of  the  business  class  on  this  matter, 
411  —  Sec.  8.  Public  regulation  the  only  alternative  to  public 
ownership.  The  two  types  of  regulating  boards.  Publicity  as  a 
means  of  supervision.  Overcapitalization.  The  essential  object 
is  to  limit  prices  and  profits.  The  elevation  of  the  standards  of 
private  management.  Supervised  quasi-public  management  only 
a  halfway  stage  ?  413. 

CHAPTER  63 

COMBINATIONS  AND  TRUSTS 419-442 

Section  1.  Combinations  in  restraint  of  trade  and  the  common 
law  rule  making  them  void.  Surprising  effectiveness  of  this  rule, 
419  —  Sec.  2.  Modern  forms  of  combination  in  the  United  States  : 
the  "trust,"  the  holding  company,  the  unified  corporation.  The 
Kartel  in  Germany.  The  fact  of  monopoly,  not  the  form  of  com- 
bination, the  important  thing,  420  —  Sec.  3.  The  permanency  of 
combination  as  affected  (1)  by  the  economies  of  large-scale  manage- 
ment; (2)  the  devices  of  "  unfair"  competition, — railway  favors, 
discriminations  in  prices,  factor's  agreements,  advertising  devices. 
The  effective  defense  against  "unfair"  competition  is  not  from 
legislation  so  much  as  from  large-scale  competition,  424  —  Sec.  4. 
Will  large-scale  competition  persist  ?  The  pressure  from  constant 
accumulation  of  fresh  capital.  Potential  competition,  and  the 
possible  emergence  of  f  oresighted  management  tinctured  by  a  sense 
of  public  responsibility,  430 — Sec.  5.  The  possible  public  advan- 
tages of  combination  lie  in  the  mitigation  of  industrial  fluctuations. 
The  supposed  ruinous  effect  of  competition  to  be  judged  from  this 
point  of  view,  433 — Sec.  6.  The  legislative  problems.  Federal  reg- 
ulation called  for  on  publicity,  capitalization,  eventually  perhaps  on 
profits  and  prices,  437  —  Sec.  7.  The  earmarks  of  monopoly  :  size, 
profits,  discriminating  prices,  439  —  Sec.  8.  Legislation  in  the  United 
States.  The  act  of  1890  and  its  enforcement.  The  acts  of  1914 ; 
the  Federal  Trade  Commission,  441. 

CHAPTER  64 

SOCIALISM «        .        .        .        .      443-459 

Section  1.  Proposals  for  large-scale  socialism  have  superseded 
those  for  isolated  communism.  The  essence  of  socialism  is  economic 


CONTENTS  xxxv 

VOL.  n 

PASM 

transformation  ;  changes  in  religion,  the  family,  political  institu- 
tions, are  not  essential  to  its  program.  Nor  is  violent  change 
essential,  443  —  Sec.  2.  Land  and  capital  to  be  in  public  hands ; 
not  necessarily  public  property  in  every  instance.  The  peculiar 
problem  as  to  agricultural  land.  Wages  to  be  the  only  form  of 
income.  Exchange  and  money  in  the  socialist  state,  446  —  Sec.  3. 
Three  conceivable  principles  of  distribution  :  need,  sacrifice,  effi- 
ciency, 449  —  Sec.  4.  How  far  public  ownership,  as  adopted  in 
present  society,  is  socialistic ;  how  far  labor  legislation  and  the 
like  are  so,  454  —  Sec.  6.  Some  current  objections  to  socialism  are 
of  little  weight ;  for  example,  that  the  huge  organization  is  imprac- 
ticable, that  goods  could  not  be  valued,  that  capital  could  not  be 
accumulated.  Would  freedom  disappear  ?  456. 

CHAPTER   65 

SOCIALISM  (continued) 460-478 

Section  1.  The  family  and  the  problem  of  population  under 
socialism.  The  Malthusian  difficulty  a  real  one,  460  —  Sec.  2. 
Vigor  and  efficiency  among  the  rank  and  file.  The  absence  of 
the  power  of  discharge.  The  irksomeness  of  labor,  462  —  Sec.  3. 
Leadership  and  the  ways  of  securing  it.  The  love  of  distinction ; 
can  it  be  satisfied  by  the  laurel  wreath  ?  Mixture  of  higher  and 
lower  aspects  in  the  love  of  distinction.  The  possible  growth  of 
altruism,  464  —  Sec.  4.  The  selection  of  leaders  in  a  socialist  state. 
Genius  and  originality  likely  to  be  deadened,  466  —  Sec.  5.  Mate- 
rial progress  through  the  improvement  of  capital  likely  to  be 
checked.  Is  a  change  in  distribution  alone  now  needed ;  can  ad- 
vance in  production  be  neglected  ?  468  —  Sec.  6.  The  problem  is 
essentially  one  of  motive  and  character.  Human  nature  and  ideals 
of  emulation  and  distinction  are  subject  to  change.  Though  social- 
ism and  current  movements  of  reform  rest  on  the  same  force,  the 
difference  in  degree  is  vast,  470  —  Sec.  7.  Is  socialism  to  be  the 
ultimate  outcome  of  social  evolution  ?  The  materialistic  interpre- 
tation of  history  and  its  prophecies.  The  certainty  that  change 
will  be  gradual  and  the  impossibility  of  foreseeing  how  far  it  will 
finally  go,  473. 

REFEREKCES  ON  BOOK  VII    .  478-479 

BOOK   VIII 
TAXATION 

CHAPTER  66 

SOME  PRINCIPLES  UNDERLYING  TAXATION 488-496 

Section  1.  The  essential  nature  of  taxation :  no  quid  pro  quo. 
Taxes  a  sign  of  wider  consciousness  of  common  interest,  483  — 


xxxvi  CONTENTS 

VOL.  U 
PASM 

Sec.  2.  Proportional  or  progressive  taxation  ?  This  question  of 
justice  inextricably^  connected  with  the  general  question  of  social 
justice  and  the  righteousness  of  inequalities  in  wealth.  "  Ability" 
and  "equality  of  sacrifice"  are  inconclusive  principles,  485  — 
Sec.  3.  Should  funded  incomes  be  taxed  at  higher  rates  than  un- 
funded ?  490  —  Sec.  4.  Can  taxes  be  made  higher  according  to  the 
source  or  nature  of  the  income  ?  492  —  Sec.  6.  Progressive  taxation 
of  interest,  on  the  principle  of  taxing  saver's  rent,  494. 


CHAPTER  67 

IHCOMB  AND  INHERITANCE  TAXES 497-514 

Section  1.  Income  taxes  present  the  problem  of  progression 
sharply ;  yet  should  be  considered  in  connection  with  other  taxes, 
497  —  Sec.  2.  Income  taxes  limited  as  a  rule  to  the  well-to-do 
classes.  The  exemption  of  small  incomes  rests  partly  on  social 
grounds,  partly  on  administrative  expediency,  498  —  Sec.  3.  The 
British  income  tax  and  the  device  of  stoppage  at  the  source.  Dec- 
larations of  a  taxpayer's  entire  income  rarely  required.  The  system 
not  consistent  with  progression,  500  —  Sec.  4.  The  Prussian  income 
tax  as  a  type  of  progressive  taxation  on  entire  income.  Declara- 
tion necessary.  Conditions  necessary  for  the  effective  administra- 
tion of  such  a  tax,  505  —  Sec.  5.  Inheritance  taxes  are  comparatively 
easy  of  enforcement,  and  lend  themselves  readily  to  progression. 
Carried  too  far,  they  check  accumulation  and  the  increase  of  capi- 
tal, 507  —  Sec.  6.  Some  further  considerations  on  inheritance  and 
income  taxes,  510 —  Sec.  7.  The  income  tax  question  in  the  United 
States.  The  constitutional  amendment  of  1913  and  the  income 
tax  of  that  year,  612. 

CHAPTER  68 

TAXES  ON  LAND  AND  BUILDINGS 616-521) 

Section  1.  Taxes  on  land  (e.g.  an  urban  site)  rest  definitively  on 
the  owner,  and  operate  to  lessen  economic  rent  by  so  much,  515  — 
Sec.  2.  Taxes  on  buildings  tend  to  be  shifted  to  the  occupier. 
Qualifications  and  limitations  of  this  proposition,  518  —  Sec.  3. 
Effects  of  taxes  on  real  property, — land  and  buildings  combined, 
521  —  Sec.  4.  In  the  long  run,  it  makes  no  difference  in  the  inci- 
dence of  such  taxes  whether  they  are  first  imposed  on  owner  or 
tenant ;  but  for  short  periods,  it  does.  Similarly,  it  is  in  the  main 
of  no  concern  whether  the  assessment  be  on  rental  or  on  capital  value; 
though  in  some  respects  the  two  ^methods  bring  different  results, 
522 — Sec.  5.  Concealed  taxation  of  workingmen  through  taxes  on 
their  dwellings,  525  —  Sec.  6.  Taxes  on  real  property  should  be 
primarily  local  taxes,  626. 


CONTENTS  xxxvii 

CHAPTER  69  TOL.  n 

PAGE* 

THE  GENERAL  PROPERTY  TAX 528-649 

Section  1.  The  general  property  tax  works  sufficiently  well  under 
simple  industrial  conditions,  528  —  Sec.  2.  In  complex  modern  com- 
munities it  is  impracticable.  Many  incomes  arise  which  do  not 
rest  on  property  ;  many  forms  of  property  are  not  readily  reached  ; 
the  development  of  debts  and  credits,  of  corporate  organization, 
causes  difficulties,  629  —  Sec.  3.  The  rate  of  taxation  important. 
Its  influence  in  the  case  of  securities.  Complete  breakdown  of  the 
system  as  to  these,  532  —  Sec.  4.  The  taxation  of  corporations  and 
of  corporate  securities.  "Double  taxation"  of  stocks  and  bonds. 
A  method  analogous  to  stoppage  at  the  source  should  be  applied. 
Difficulties  of  apportionment  between  conflicting  jurisdictions,  536 
—  Sec.  5.  Mortgages  and  mortgage  notes  present  similar  problems, 
540  —  Sec.  6.  Public  securities  present  especial  difficulties  for  a 
property-tax  system.  Is  it  expedient  to  exempt  them  from  taxa- 
tion ?  543  —  Sec.  7.  Possible  ways  of  reforming  American  methods 
of  taxing  securities :  complete  exemption,  moderate  tax  on  capital 
value,  tax  on  the  income,  644  —  Sec.  8.  A  question  of  principle: 
how  far  can  the  taxation  of  income-yielding  property  be  carried 
without  checking  accumulation  ?  647. 

CHAPTER  70 

TAXES  ON  COMMODITIES 660-560 

Section  1.  Direct  and  indirect  taxes.  Various  ways  in  which 
"indirect"  taxes  are  levied  on  commodities,  550  —  Sec.  2.  In  the 
simplest  case,  of  a  competitive  commodity  produced  under  constant 
returns,  a  tax  tends  to  be  shifted  to  consumers.  Explanation  and 
qualification  of  this  principle,  551  —  Sec.  3.  Complexities  where  the 
commodity  is  produced  under  increasing  or  diminishing  returns; 
where  there  is  monopoly.  Cautions  to  be  observed  in  the  applica- 
tion of  theoretic  reasoning  on  these  topics,  553  —  Sec.  4.  Taxes  on 
imports  present  no  peculiarities,  except  as  they  bring  a  rival  un- 
taxed  supply  and  thus  raise  the  questions  concerning  protection, 
667  —  Sec.  5.  Taxes  on  commodities  are  little  noticed  by  con- 
sumers. They  are  commonly  on  articles  of  large  consumption, 
and  regressive  in  their  effects.  A  large  and  varied  list  of  article* 
is  most  easily  reached  by  customs  duties,  557. 

REFERENCES  ON  BOOK  VIII  ..,.,,...     561 


BOOK  I 

THE  ORGANIZATION  OF  PRODUCTION 


CHAPTER   1 
OF  WEALTH  AND  LABOR 

§  1.  To  define  with  accuracy  the  scope  and  contents  of  eco- 
nomics is  not  of  importance  in  the  earlier  stages  of  its  study. 
The  precise  demarcation  of  its  subject  matter,  and  its  relation 
to  other  branches  of  knowledge,  can  be  understood  only  when 
something  is  known  of  its  main  conclusions.  It  suffices  at  the 
outset  to  indicate  by  an  example  what  is  the  nature  of  the  prob- 
lems dealt  with.  A  good  example  is  found  in  the  economic 
position  of  one  of  the  most  familiar  articles  of  use,  —  water. 

In  a  thinly  settled  community,  where  springs  and  streams 
are  abundant,  water  is  free  to  all.  No  question  can  arise  as 
to  its  ownership  or  as  to  the  mode  in  which  the  community 
should  deal  with  it.  Every  one  is  fortunate  in  having  an 
unlimited  supply.  No  one  can  gain  advantage  by  taking 
possession  of  part  of  it,  or  devoting  labor  to  procuring  it. 

Water  under  such  conditions  is  said  to  be  a  "free"  good, 
not  an  "economic"  good.  It  is  not  an  economic  good,  in  the 
sense  that  no  economic  problems  arise  regarding  it.  Every  one 
has  all  he  wants,  and  thereby  is  prospered ;  what  more  is  there 
to  say? 

A  stage  may  come  very  early  when  some  labor  will  be  given 
to  making  the  water  conveniently  available,  and  when  it  will 
be  no  longer  strictly  a  free  good;  and  when  yet  no  economic 
questions  of  any  complexity  arise.  The  individual  may  dig 
a  well,  or  pipe  the  water  from  a  spring  or  stream  to  his  dwelling. 
The  very  first  economic  problem,  that  which  may  even  be 
considered  the  fundamental  problem,  then  emerges :  How  much 
effort  is  it  worth  while  to  give  to  the  supply  of  this  convenience  ? 

3 


4  THE   ORGANIZATION  OF  PRODUCTION 

But  the  problem  remains  a  very  simple  one,  so  long  as  the  in- 
dividual exerts  himself  to  satisfy  his  own  wants  only.  There 
is  no  dealing  with  others,  no  sale,  no  question  of  price.  If  men 
were  to  work  solely  for  the  satisfaction  of  their  own  wants, 
the  difficult  economic  questions  would  not  arise  at  all. 

A  more  complex  stage  is  reached  when  water  is  brought  in  by 
some  individuals  and  sold  to  others.  In  Oriental  towns  the 
water  carrier,  with  his  runlet  or  skin,  is  still  a  familiar  figure. 
In  our  own  cities  private  individuals  sometimes  sell  carboys 
of  spring  water  or  distilled  water.  Here  questions  of  sale  and 
price  arise.  What  settles  the  terms  on  which  water  is  sold? 
What  settles  the  earnings  of  those  who  supply  it?  Are  they 
in  a  position  of  advantage  or  not?  Here  are  matters  less 
simple. 

Still  another  stage  (not  necessarily  a  later  stage)  is  reached 
when  common  action  is  taken  to  procure  the  water.  Here  the 
problem  may  remain  comparatively  simple,  or  it  may  become 
one  of  the  troublesome  problems  of  modern  communities. 
The  traveler  in  Italy  sees  the  village  fountain,  supplied  by  its 
aqueduct ;  even  in  larger  towns,  through  some  parts  of  Europe, 
the  public  fountain  has  remained  until  very  recently  the  chief 
source  of  supply.  The  water  is  no  longer  strictly  a  "free" 
good,  since  effort  and  expense  were  required  to  bring  it  where 
wanted.  But  the  effort  was  made  long  ago,  does  not  need  to 
be  renewed  (there  are  no  expenses  of  upkeep),  and  there  is  so 
much  water  that  it  can  be  used  ad  libitum.  In  the  modern 
city,  however,  the  case  has  become  different.  There  are  great 
reservoirs,  elaborate  pumping  stations,  mains,  and  pipes. 
Water  is  supplied  abundantly  and  conveniently  to  every  house- 
hold. There  is  not  only  a  vast  initial  outlay  for  the  plant,  but 
a  continuing  cost  of  upkeep.  The  questions  arise,  Who  shall 
make  the  outlay  and  manage  the  supply  ?  Shall  there  be  public 
or  private  ownership?  And,  whether  under  public  or  private 
ownership,  what  are  to  be  the  conditions  of  sale?  Conceiv- 
ably the  water,  if  under  public  management,  may  still  be  sup- 
plied gratuitously  to  all,  as  it  is  at  the  village  fountain;  or 


OF  WEALTH  AND  LABOR  5 

payment  may  be  required  of  the  users.  The  questions  of  profit 
arise,  of  sound  public  policy,  of  possible  monopoly  gains,  of  con- 
flict between  financial  and  hygienic  considerations.  The  really 
complex  problems  of  economics  arise  full-fledged. 

§  2.  To  designate  these  different  sorts  of  conditions,  some 
quasi-technical  terms  are  often  used:  "free  goods,"  "economic 
goods,"  "public  goods,"  "wealth." 

What  are  free  goods  and  what  are  economic  goods  has  just 
been  indicated.  Fresh  air,  climate,  sunshine,  are  the  obvious 
cases  of  free  goods ;  so  is  water  under  the  simplest  conditions, 
or  standing  timber  in  a  thinly  settled  and  well-wooded  country. 

Scarcity  is  the  earmark  of  an  economic  good,  —  scarcity, 
that  is,  relatively  to  the  demand.  Water  becomes  an  economic 
good  when  effort  is  needed  to  obtain  it  in  the  quantity  desired, 
at  the  place  of  use.  It  is  conceivable  that  in  the  future  fresh 
air  may  become,  for  considerable  parts  of  mankind,  an  economic 
good.  It  is  so  already  when  many  persons  are  gathered  in  a 
large  room  or  hall.  Fans,  conduits,  engines,  are  installed;  it 
becomes  a  question  how  the  needful  efforts  shall  be  best  directed, 
who  shall  bear  the  expense.  With  the  concentration  of  popu- 
lation in  great  cities,  and  the  multiplication  of  agencies  that 
pollute  the  air  in  them,  it  is  possible  that  elaborate  means 
will  have  to  be  taken  for  keeping  it  healthful.  Then  the 
same  complex  problems  will  present  themselves  as  in  the  case 
of  water;  all  resting  on  the  relative  scarcity  of  the  thing  in 
question. 

"Public  goods"  are  economic  goods  supplied  gratuitously 
to  individuals,  yet  involving  effort  and  consequent  expense  to 
some  one.  Though  free  to  the  users,  they  are  not  free  goods. 
Such  is  water  at  the  public  fountain ;  such  are  public  education, 
parks,  museums,  free  concerts,  bridges,  and  highways.  What 
goods  shall  be  public,  and  by  whom  the  expense  of  providing 
them  shall  be  met,  —  whether  by  levy  on  all  persons,  or  on  some 
only,  —  these  are  the  problems  as  to  public  functions  and  as 
to  taxation  for  defraying  their  expense;  among  the  most  diffi- 
cult and  far-reaching  that  the  economist  has  to  deal  with. 


6  THE  ORGANIZATION  OF  PRODUCTION 

It  was  common  in  the  older  books  on  our  subject  to  define 
political  economy  (a  phrase  replaced  in  modern  times  by  the 
simpler  "economics")  as  the  "science  of  wealth."  In  this 
usage,  "wealth"  meant  all  the  economic  goods,  including  the 
public  goods.  Either  term  —  wealth  or  economic  goods  — 
serves  to  describe  the  subject  matter  with  which  economics 
has  to  deal ;  those  things  which  men  want,  which  are  not  free, 
and  which  present  the  problems  of  effort,  of  satisfaction  through 
effort,  of  the  organization  of  industry. 

Evidently  a  community  is  the  better  off,  the  more  free  goods 
it  has  and  the  less  the  range  of  things  that  come  within  the 
category  of  "wealth."  Where  unlimited  pure  water  and  fresh 
air  are  at  every  one's  disposal,  the  conditions  of  life  are  eased 
by  so  much.  A  mild  and  equable  climate  relieves  the  people 
of  some  favored  spots  from  much  labor  that  must  be  given  else- 
where to  protection  from  heat  or  cold.  It  may  be  said,  with 
an  appearance  of  paradox,  that  the  more  things  in  the  nature 
of  wealth  a  community  has,  the  less  prosperous  it  is.  The 
paradox  is  easily  solved.  The  wealth  of  a  community  is  not 
the  sum  total  of  things  on  which  its  welfare  depends,  —  these 
include  its  free  goods  as  well  as  its  economic  goods.  The  more 
things  are  free,  the  easier  are  the  conditions  of  living.  The 
more  things  are  economic,  the  wider  is  the  range  of  commodities 
concerning  which  the  economic  problems  arise,  and  the  wider 
is  the  scope  of  the  science  of  "wealth." 

The  abundance  of  free  goods,  though  prima  facie  advanta- 
geous to  a  community,  does  not  always  coexist  with  the  highest 
degree  of  prosperity.  In  tropical  and  semitropical  countries 
the  conditions  of  living  are  on  the  whole  easier  than  in  temperate 
countries.  Some  sorts  of  food  are  free  or  nearly  free,  and 
protection  does  not  need  to  be  provided  against  the  cold  of 
winter.  But  the  climate  saps  energy,  and  checks  the  develop- 
ment of  physical  vigor  and  of  intellectual  capacity.  Hence 
the  peoples  of  temperate  regions,  from  the  very  obstacles  they 
have  to  overcome,  gain  resources  within  themselves  which 
lead  eventually  to  greater  prosperity.  So  it  is  with  individuals. 


OF  WEALTH  AND  LABOR  7 

He  who  has  always  had  abundant  means  at  his  command  often 
lacks  endurance  and  spirit,  and  in  the  end  is  surpassed  in  hap- 
piness as  well  as  in  riches  by  him  who  had  to  face  harder  con- 
ditions at  the  start. 

§  3.  In  the  preceding  paragraph  wealth  has  been  spoken  of 
as  the  result  of  effort.  But  there  are  cases  where  a  commodity 
is  wealth,  —  is  an  economic  good,  —  even  though  it  be  obtained 
without  effort.  A  free  gift  of  nature  may  be  wealth,  if  it  is 
limited  in  quantity. 

On  some  parts  of  the  seashore  the  waves  dislodge  from  near- 
lying  rocks  quantities  of  kelp,  which  is  useful  as  a  fertilizer. 
Like  multitudes  of  other  articles,  its  use  is  indirect;  it  does  not 
satisfy  wants  directly,  but  is  an  aid  in  the  operations  for  satis- 
fying them.  Obviously,  it  may  none  the  less  be  wealth.  If 
kelp  were  steadily  borne  to  the  shore  in  such  quantities  that 
every  one  could  get  all  he  wished,  it  would  be  a  free  good  in 
the  strict  economic  sense.  But  if  it  is  deposited  in  limited 
quantities  on  favored  spots,  and  if  many  farmers  are  desirous 
of  using  it,  it  will  command  a  price  as  it  lies  on  the  beach,  before 
even  the  hand  of  man  has  touched  it.  And  the  same  supply 
which  at  one  time  was  so  abundant  as  to  command  no  price, 
may  be  brought  by  the  growth  of  population  within  the  circle 
of  things  bought  and  sold,  and  so  become  one  of  the  goods  with 
which  economic  science  deals.  Meteoric  stones,  usually 
disintegrated  by  heat  before  touching  the  earth's  surface,  in 
some  instances  reach  the  ground.  Being  scarce,  and  in  our 
days  esteemed  for  scientific  research  or  even  for  the  satisfac- 
tion of  mere  curiosity,  they  command  a  price,  and,  though  the 
free  gift  of  nature,  are  not  free  goods  in  the  economic  sense. 

The  same  narrowing  of  the  circle  of  free  goods,  and  the  same 
widening  of  that  of  economic  goods  or  wealth,  appear  if  there 
be  not  a  natural,  but  an  artificial,  scarcity  of  goods.  A  supply 
of  water  or  timber,  unlimited  in  quantity  for  the  needs  of  a 
given  community,  may  come  by  force  or  by  long-settled  law 
under  the  control  of  some  individual  or  individuals.  By  limit- 
ing the  amount  which  others  shall  have,  the  owners  may  make 


8  THE  ORGANIZATION  OF  PRODUCTION 

such  things  a  source  of  income  for  themselves  and  cause  them 
to  enter  the  list  of  economic  goods.  Monopoly  per  se  raises 
some  of  the  questions  with  which  economic  science  has  to  deal. 

This  simplest  sort  of  scarcity  may  seem  to  be  exceptional ; 
and  as  to  the  things  which  we  usually  think  of  as  goods  or 
commodities,  it  is  so.  The  instances  just  adduced  are  excep- 
tional. In  the  vast  majority  of  cases  commodities  become 
economic  after  some  labor  has  been  applied  to  fashioning  them. 
Though  scarcity  (that  is,  relative  scarcity)  still  underlies  the 
notion  of  wealth  or  economic  goods,  it  is  scarcity  in  the  sense 
that  the  materials  supplied  by  nature  need  to  be  adapted  to 
man's  use  by  his  labor.  Labor,  or  effort  of  some  sort,  is  usu- 
ally the  cause  or  condition  of  economic  phenomena. 

There  is  one  large  class  of  things,  however,  for  which  this 
statement  does  not  hold :  limited  natural  agents,  of  which  land 
is  the  most  conspicuous.  These  are  not  commonly  called  goods 
or  wares;  but  they  are  economic  goods  in  the  strict  sense, 
being  limited  in  quantity  and  of  high  service  in  satisfying  wants. 
Agricultural  land,  power  and  deep-water  sites,  forests,  mineral 
lands,  —  all  are  often  economic  goods  by  virtue  of  mere  natural 
limitation  of  quantity.  They  present,  as  will  appear  in  due 
course,  some  of  the  most  intricate  social  and  economic  problems. 

§  4.  What  is  labor,  may  seem  a  simple  matter.  Most  people 
would  say  that  they  are  more  than  sufficiently  familiar  with 
it.  Yet  some  questions  arise  concerning  it  that  go  to  the  heart 
of  economics,  and  the  last  word  on  them  cannot  be  said  until 
the  very  close  of  the  exposition  of  the  whole  subject. 

Some  activities  are  agreeable,  some  are  irksome.  Some  are 
undertaken  for  the  pleasure  of  doing,  some  for  a  reward.  Not 
infrequently  the  two  satisfactions  are  gained  simultaneously 
from  the  selfsame  activity;  it  is  both  a  source  of  pleasure  in 
itself,  and  it  brings  a  reward. 

So  far  as  the  nature  of  the  muscular  or  nervous  effort  is  con- 
cerned, no  distinction  can  be  drawn  between  the  agreeable  and 
the  irksome  activities,  or  between  those  which  are  undertaken 
for  pleasure  and  those  which  are  undertaken  for  pay.  Such 


OF  WEALTH  AND  LABOR  9 

severe  physical  labor,  combined  with  hardship  and  exposure, 
as  mountain  climbing,  is  done  for  pleasure  by  tourists  and  for 
pay  by  guides.  The  pursuit  of  athletic  sports  is  the  most  fa- 
miliar of  recreations  and  is  also  a  familiar  profession.  A  multi- 
tude of  occupations  ordinarily  pursued  for  gain  —  woodworking, 
gardening,  painting,  acting  —  are  also  pursued  by  many  persons 
for  the  satisfaction  which  the  doing  affords. 

None  the  less  it  is  true  that  the  greatest  part  of  the  activity 
which  men  carry  on  in  getting  a  living  does  not  give  pleasure. 
The  chief  reason  seems  to  be  that  activity,  in  order  to  be  effec- 
tive toward  getting  a  living,  must  be  steady,  unvaried,  and 
long-continued;  and  it  must  be,  in  an  important  sense,  not 
free.  The  characteristic  of  most  activities  that  are  sources 
of  pleasure  in  themselves  is  the  element  of  freshness  or  novelty, 
and  the  absence  of  compulsion.  The  guide  who  climbs  moun- 
tains year  after  year,  and  knows  the  tracks  by  heart,  soon 
finds  the  task  a  weary  one ;  and  this  the  more,  because,  in  order 
to  earn  his  living,  he  must  follow  his  tracks  regularly,  regardless 
of  his  health  or  spirits  at  the  moment.  It  is  the  zest  of  novelty 
and  the  sense  of  freedom  and  choice  that  cause  pleasure  in 
the  summer's  arduous  vacation.  Inactivity  and  idleness  soon 
become  irksome;  but,  with  few  exceptions,  steady  application 
to  the  same  task  also  soon  becomes  irksome. 

In  savage  and  barbarian  communities,  the  men  usually 
confine  themselves  to  the  chase  and  to  war.  The  monotonous 
work  of  cultivating  fields  and  of  preparing  food  is  left  to  the 
women.  Though  hunting  and  fishing  often  entail  the  most 
strenuous  exertion  and  the  severest  hardship,  they  do  not  com- 
monly endure  long,  and  they  are  almost  surely  varied  by  changes 
and  respites.  The  variety  and  the  sudden  changes  give  play 
for  emulation  and  for  satisfying  the  love  of  distinction,  —  that 
for  slaughter  also,  —  instincts  which  have  a  powerful  effect  in 
many  fields  of  economic  activity.  An  alternation  of  periods 
of  complete  idleness  and  of  feverish  activity  is  characteristic 
of  those  early  stages  of  society  in  which  men  give  themselves 
to  the  unchecked  satisfaction  of  their  instinctive  propensities. 


10  THE  ORGANIZATION  OF  PRODUCTION 

The  sort  of  labor  that  occupies  the  mass  of  mankind  in  civ- 
ilized societies,  and  that  which  brings  the  largest  product, 
is  mainly  of  the  continuous,  monotonous,  and  irksome  kind. 
This  is  more  especially  the  case  where  the  division  of  labor  has 
been  much  elaborated.  The  wide  extension  of  the  division 
of  labor,  as  we  shall  presently  see,  has  been  a  main  cause  in 
modern  times  of  the  greater  abundance  of  material  goods, 
and  of  the  extraordinary  advance  in  material  prosperity. 
But  it  has  probably  also  been  a  cause  of  greater  weariness  and 
unattractiveness  for  most  labor.  Even  in  the  simpler  and 
older  form  of  the  division  of  labor,  where  one  man  was  carpenter, 
another  smith,  another  cobbler,  there  was  of  necessity  a  steady 
repetition  of  operations  and  no  little  monotony  of  work.  But 
in  the  remarkable  splitting  up  of  occupations  which  has  resulted 
from  the  elaboration  of  machinery  in  modern  times,  it  is  rare 
that  a  workman  does  all  the  work  of  his  trade,  or  even  knows 
how  to  do  it.  He  is  no  longer  a  cobbler  making  a  whole  shoe, 
but  a  factory  hand  attending  hour  after  hour  and  week  after 
week  to  the  same  minute  piece  of  machine  work.  Moreover, 
in  a  dense  population  and  with  strictly  enforced  ownership  of 
property  and  of  land,  he  is  under  compulsion  to  do  continuous 
work  of  some  such  sort,  in  order  to  keep  body  and  soul  to- 
gether. He  lacks  variety,  and  he  lacks  freedom.  He  may  find 
pleasure  in  exerting  himself  strenuously  at  sports ;  but  the  labor 
of  getting  his  living  yields  in  itself  little  satisfaction. 

§  5.  Some  sorts  of  labor,  though  pursued  systematically  and 
continuously,  seem  never  to  become  wearisome.  This  is  the 
case  with  much  intellectual  labor,  especially  that  of  persons 
who  are  engaged  in  the  pursuit  of  knowledge  and  in  the  satisfac- 
tion of  man's  insatiable  curiosity  about  the  things  that  surround 
him.  Persons  of  artistic  temperament  —  painters,  musicians, 
poets  —  have  often  so  strong  an  instinctive  bent  toward  one 
kind  of  activity  that  nothing  can  hold  them  from  it  and  nothing 
ever  pall  the  pleasure  of  the  exertion.  And  any  occupation 
which  satisfies  the  instinct  of  emulation  has  unceasing  charm. 
He  who  can  achieve  things  which  few  can  achieve,  and  which 


OF  WEALTH  AND  LABOR  11 

many  would  like  to  achieve,  rarely  tires  of  his  work.  The  actor, 
even  though  his  occupation  involves  the  monotonous  and  long- 
continued  repetition  of  the  most  trifling  details,  never  fails 
to  get  a  thrill  of  pleasure  from  the  breathless  silence  or  stirring 
applause  of  his  audience.  Were  he  compelled  to  go  through 
his  part  as  often  and  as  rigorously  under  the  cold  supervision 
of  an  indifferent  supervisor,  and  under  that  only,  how  flat  and 
stale  it  would  become  !  For  a  similar  reason,  work  of  leader- 
ship and  command  almost  always  is  continuously  pleasurable. 
It  satisfies  the  love  of  distinction  and  the  desire  for  domination ; 
and  it  has  a  real  or  apparent  element  of  freedom.  Hence 
the  work  of  the  employer  commonly  affords  more  satisfaction 
than  that  of  the  employee,  and  often  is  continued,  from  mere 
love  of  the  doing  as  well  as  from  habit,  long  after  the  reward 
or  profit  from  the  exertion  has  ceased  to  be  valued. 

These  exceptions  should  not  blind  us  to  the  fact  that  by  far 
the  greater  part  of  the  world's  work  is  not  in  itself  felt  to  be 
pleasurable.  Some  reformers  have  hoped  to  reach  a  social 
system  under  which  all  work  should  be  in  itself  a  source  of  satis- 
faction. It  is  probable  that  such  persons  are  made  optimistic 
by  the  nature  of  their  own  doings.  They  are  writers,  schemers, 
reformers;  they  are  usually  of  strongly  altruistic  character, 
and  the  performance  of  any  duty  or  set  task  brings  to  them 
the  approval  of  an  exacting  conscience ;  and  they  believe  that 
all  mankind  can  be  brought  to  labor  in  their  own  spirit.  The 
world  would  be  a  much  happier  place  if  their  state  of  mind  could 
be  made  universal.  But  the  great  mass  of  men  are  of  a  hum- 
drum sort,  not  born  with  any  marked  bent  or  any  loftiness  of 
character.  Moreover,  most  of  the  world's  work  for  the  satis- 
faction of  our  primary  wants  must  be  of  a  humdrum  sort,  and 
often  of  a  rough  and  coarse  sort.  There  must  be  ditching  and 
delving,  sowing  and  reaping,  hammering  and  sawing,  and  all 
the  severe  physical  exertion  which,  however  lightened  by  tools 
and  machinery,  yet  can  never  be  other  than  labor  in  the 
ordinary  sense  of  the  term. 

Reference  has  just  been  made  to  a  greater  monotony  of 


12  THE  ORGANIZATION  OF  PRODUCTION 

labor  in  modern  times,  under  the  influence  of  growing  use  ol 
machinery  and  growing  specialization  of  labor.  But  the  extent 
of  the  change  in  this  regard  may  be  easily  exaggerated.  Ruskin 
has  dwelt  on  the  charm  of  the  medieval  craftsman's  task, 
who  felt  the  joy  of  work  that  had  beauty  and  character.  Yet 
this  joy  was  probably  shared  by  few  in  medieval  times,  or 
in  any  other.  Then,  as  now,  most  work  involved  the  repetition 
of  the  same  operations,  and  was  felt  to  be  tedious  and  exacting. 
It  is  not  easy  for  us  to  picture  the  conditions  of  life  in  earlier 
societies,  organized  in  a  very  different  way  from  our  own ;  but 
it  is  more  than  probable  that  the  mass  of  mankind  found  their 
tasks  then  on  the  whole  no  pleasanter  or  lighter  than  now. 

§  6.  We  may  hope  that,  as  the  material  conditions  of  man- 
kind improve,  especially  in  the  countries  of  advanced  civiliza- 
tion, gains  will  be  achieved  as  regards  the  irksomeness  of  ordi- 
nary labor.  Some  alleviation  will  come  from  a  mere  change 
in  the  state  of  opinion  in  the  community.  The  sense  of  dis- 
tinction affects  the  satisfaction  from  exertion.  A  task  admired 
is  an  attractive  task,  and  one  despised  is  unattractive.  The 
common  attitude  of  the  more  favored  classes  has  long  been  to 
contemn  manual  labor  and  those  who  perform  it.  Such  was 
the  natural  attitude  in  communities  based  on  slavery,  or  on  its 
successor,  feudalism ;  and  such  remains  too  often  the  attitude 
of  that  leisure  class  which  in  modern  times  adopts  many  of  the 
traditions  of  feudalism.  The  growing  democratization  of  society 
may  be  expected  to  change  this,  and  to  raise  the  dignity  and 
self-respect  of  labor  of  all  kinds,  manual  or  mental.  Greater 
ease  of  movement  between  different  classes  and  greater  equali- 
zation of  their  conditions  will  add  to  the  esteem  in  which  all 
kinds  of  manual  labor  are  held,  and  may  remove  some  at  least 
of  the  causes  that  now  contribute  to  make  it  unwelcome. 

The  chief  mode,  nevertheless,  in  which  labor  is  likely  to  be 
made  less  irksome  is  not  by  a  change  in  its  character  or  its 
intrinsic  attractiveness,  but  by  a  diminution  in  its  severity. 
It  will  probably  be  lightened  by  the  increasing  perfection  of 
tools  and  the  increasing  use  of  machinery  ;  though  on  the  other 


OF  WEALTH  AND  LABOR  13 

hand,  it  may  be  that  from  this  cause  its  monotony  will  become 
no  less,  perhaps  greater.     More  important  is  the  prospect  that 
the  hours  of  labor  are  likely  to  be  shortened,  and  the  hours  for 
recreation  and  variety  correspondingly  lengthened.     The  weari- 
ness of  labor  is  by  no  means  in  proportion  to  the  number  of 
hours  spent  on  it.     For  a  healthy  and  well-nourished  person, 
the  first  hours  of  work  are  not  a  source  of  fatigue.     Some  writers 
have  indeed  maintained  that  during  these  earlier  hours  —  bar- 
ring perhaps  a  brief  initial  period  of  stiffness  —  there  is  a  sense  of 
pleasure  rather  than  of  pain.     This  may  be  the  case  in  intellec- 
tual activity,  and  in  some  handicraft  occupations;    and  the 
experience  is  a  familiar  one  in  holiday  jaunts.     But   little 
direct  consciousness  of  pleasure  comes  at  any  stage  from  the 
stated  work  of  the  great  majority  of  men.     The  difference 
between  the  earlier  parts  of  their  day  and  the  later  is  not  so 
much  that  the  former  are  pleasant  and  the  latter  unpleasant, 
as  that  fatigue  does  not  begin  until  some  hours  have  passed,  and 
then  becomes  increasingly  severe  with  each  of  the  later  hours. 
When  indeed  the  hours  of  labor  are  unduly  prolonged,  fatigue 
becomes  so  great  and  so  deep-seated  that  the  period  of  rest 
and  sleep  does  not  suffice  to  remove  it.     The  next  day  begins 
again  with  fatigue,  and  worse  succeeds  worse.     Such  was  the 
effect  of  the  factory  system  in  its  early  stages  in  England ;  such 
is  still  the  situation  in  backward  countries  like  Russia.     Under 
these  wretched  conditions,  the  work  of  the  day  has  covered 
eleven,  twelve,  even  fourteen,  hours.     In  the  United  States, 
in  our  own  day,  some  of  the  steel-making  industries,  whose 
operations  go  on  night  and  day,  have  had  two  shifts,  in  each  of 
which  the  men  worked  twelve  hours.     To  cut  off  one,  two, 
three  hours,  from  such  a  day's  labor  is  to  cut  off  a  much  larger 
proportion  of  the  weariness  of  labor. 

The  movement  for  shorter  hours  has  been  one  of  the  most 
beneficent  aspects  of  the  betterment  of  material  conditions 
in  civilized  countries  during  the  last  two  or  three  generations. 
The  day's  labor  was  first  cut  down  to  eleven  and  ten,  partly 
from  the  pressure  of  workmen's  organizations  and  partly  from 


14  THE  ORGANIZATION  OF  PRODUCTION 

legislation  restricting  the  hours  of  women  and  children  em- 
ployed in  factories.  It  is  still  in  process  of  being  reduced. 
The  ideal  of  the  trade  unions  is  now  to  lower  it  to  eight 
hours;  a  limit  which  has  already  been  reached  in  the  more 
prosperous  and  highly  paid  trades,  and  is  likely  to  be  at- 
tained by  a  larger  and  larger  proportion  of  manual  workers. 
We  shall  have  occasion  to  consider  at  a  later  stage  the  signifi- 
cance of  this  shortening  of  the  period  of  work,  the  nature 
and  causes  of  the  gains  so  secured,  and  the  fallacies  which  have 
attached  themselves  to  the  short-hour  movement.1  But  in 
itself  that  movement  should  have  the  sympathy  of  every  friend 
of  humanity. 

Notwithstanding  all  the  alleviations  of  the  irksomeness  of 
labor,  —  through  moderate  tasks,  free  time  for  recreation, 
a  rational  respect  for  labor  of  all  kinds,  —  the  larger  part  of 
the  world's  work  will  always  be  felt  to  be  irksome.  A  fortunate 
minority  may  work  at  tasks  which  are  in  themselves  pleasur- 
able and  are  not  performed  chiefly  for  the  return  which  they 
bring.  But  most  work  is  now  undertaken  for  reward,  would 
not  be  done  without  reward,  and  is  strenuous  and  well  directed 
in  proportion  to  the  reward.  It  is  doubtless  true  that  the  mass 
of  mankind,  though  they  find  their  labor  irksome  or  repellent, 
are  yet  happier  than  they  would  be  under  complete  idleness,  or 
with  only  that  fitful  kind  of  exertion  which  attracts  the  savage. 
But  labor  is  commonly  felt  to  be  a  hardship,  and  the  pay  which 
it  secures  is  the  dominant  motive  for  undertaking  it.  The 
fundamental  problems  that  arise  in  economics  are  concerned 
with  the  relation  between  unwelcome  exertion  and  the  remu- 
neration which  induces  that  exertion. 

» See  Book  VI,  Chapter  56. 


CHAPTER  2 
OF  LABOR  IN  PRODUCTION 

§  1.  The  relation  of  labor  to  production  may  seem  simple. 
Yet  it  has  been  the  occasion  of  great  difference  of  opinion  among 
acute  thinkers,  and  it  presents  some  nice  questions. 

We  commonly  speak  of  a  tailor  as  making  clothes,  a  carpenter 
as  making  a  table,  a  cobbler  as  making  boots.  The  briefest 
reflection  shows  that  this  is  a  careless  use  of  language.  The 
labor  of  the  tailor  but  gives  the  finishing  touch  to  the  work 
previously  done  by  a  long  series  of  persons,  —  the  shepherd 
who  tended  the  flocks,  the  wool  shearer,  those  who  transported 
the  wool  by  land  and  sea,  the  carder  and  spinner  and  weaver, 
not  to  mention  those  who  made  the  tools  and  machinery  of 
these  workers.  Similarly  the  carpenter  is  the  last  of  a  succession 
of  persons  who  worked  toward  a  common  end,  —  those  who 
felled  the  trees,  fashioned  the  timber,  transferred  it  from  the 
woods,  and  so  on.  Many  laborers,  arranged  in  long  series, 
combine  in  making  even  the  simplest  commodities. 

But  it  is  clearly  all  these  laborers,  taken  together,  who  pro- 
duce the  commodities ;  and  can  it  not  be  said  these  alone  are 
the  producers  of  wealth?  Wealth  has  been  described  as  con- 
sisting of  those  goods  which  are  not  free.  The  term  refers 
primarily  to  things  that  are  tangible  and  material.  Many 
laborers  produce  no  wealth  in  this  sense.  Such  are  domestic 
servants,  policemen,  actors,  singers,  teachers.  Does  not  their 
work  stand  in  a  different  relation  to  production  from  that  of 
laborers  who  make  material  things  and  carry  on  production 
in  the  common  meaning  of  the  word  ? 

This  was  the  opinion  of  many  of  the  earlier  writers  on  eco- 
nomics, especially  the  English  writers  from  Adam  Smith  to  John 
Stuart  Mill.  Their  view  was  that  only  such  laborers  as  turned 

15 


16  THE  ORGANIZATION  OF  PRODUCTION 

out  material  things  were  productive;  all  others  were  unpro* 
ductive.  A  liberal  interpretation  was  indeed  given  to  their 
definition  of  the  productive  laborers.  Not  only  those  who 
directly  handled  materials  and  fashioned  them  were  included, 
—  the  day  laborer,  the  carpenter,  and  the  smith ;  but  those  also 
by  whom  the  operations  were  guided  and  promoted,  —  the  em- 
ployer who  directed  the  manual  laborers,  the  foreman  and  the 
engineer,  the  teacher  who  trained  the  engineer.  Even  the 
teacher  of  the  humblest  workman  may  conceivably  be  re- 
garded as  contributing  to  the  operations  of  material  production, 
in  so  far  as  the  diffusion  of  even  the  rudiments  of  education 
raises  intelligence  and  adds  to  efficiency.  But  with  the  widest 
latitude  in  interpretation,  a  great  range  of  persons,  doing  all 
sorts  of  work  and  by  it  earning  a  living,  remained  outside  the 
class  of  the  so-called  productive  laborers.  Domestic  servants, 
lawyers  and  judges  and  policemen,  all  the  army  and  navy, 
not  to  mention  persons  who  provided  mere  amusement,  were 
classed  as  unproductive.  As  Adam  Smith  remarked,  "in  the 
same  class  [of  unproductive  laborers]  must  be  ranked,  some 
both  of  the  gravest  and  most  important  and  some  of  the  most 
frivolous  professions :  churchmen,  lawyers,  physicians,  men 
of  letters  of  all  kinds;  players,  buffoons,  musicians,  opera 
singers,  opera  dancers." 

This  distinction  between  productive  and  unproductive 
laborers  was  early  attacked  and  long  debated.  It  was  pointed 
out  that  it  seemed  to  affix  some  sort  of  stigma  —  an  accusation 
of  uselessness,  of  being  in  need  of  support  from  others  —  on 
whole  classes  of  persons  whose  work  was  admitted  to  be  hon- 
orable and  often  seemed  to  be  indispensable.  But  this  was 
after  all  not  material;  whether  or  no  an  "unproductive"  occu- 
pation was  to  be  regarded  as  honorable,  the  essential  question  was 
and  is  whether  there  are  differences  between  this  kind  of  work 
and  the  other  which  are  important  for  the  welfare  of  the  com- 
munity. It  was  much  more  to  the  point  that  the  distinction 
led  to  difficulties  and  inconsistencies.  The  musician  was 
regarded  as  an  unproductive  laborer;  was  the  artisan  who 


OF  LABOR  IN  PRODUCTION  17 

made  his  instrument  —  his  violin  —  nevertheless  productive  ? 
The  labor  of  the  violin-maker  issued  in  material  wealth,  or, 
as  Adam  Smith  said,  in  "a  vendible  commodity."  Yet  its 
only  object  was  to  make  an  instrument  to  be  used  by  the  musi- 
cian; and  was  not  the  consistent  view  that  of  regarding  the 
two  sets  of  persons  as  combining  for  a  common  result,  just  as 
the  sheep  shearer,  the  weaver,  and  the  tailor  combine  in  making 
clothing  ?  And  if  thus  working  together  for  the  same  end,  was 
one  to  be  set  apart  as  productive,  the  other  as  unproductive? 
All  members  of  the  navy  and  army  were  classed  as  unproduc- 
tive; yet  those  who  built  the  ships,  made  the  guns  and  the 
powder,  were  supposed  to  be  productive.  If  one  set  were 
unproductive,  why  not  the  other  ? 

§  2.  The  solution  of  these  difficulties  is  indicated  by  a  con- 
ception which  the  British  economists,  though  they  followed  it  in 
other  directions,  were  curiously  slow  to  use  with  reference  to 
their  discussion  of  productive  labor.  It  points  to  satisfactions, 
or  utilities,  as  the  aim  and  end  of  production.  We  shall  see, 
as  we  progress,  how  hi  various  directions  economic  science 
gains,  and  is  often  brought  to  unity  and  consistency,  by  the 
analysis  of  production  as  ending  in  utilities. 

If  it  is  a  careless  use  of  language  to  speak  of  a  carpenter  as  "mak- 
ing" a  table,  it  may  also  be  said  to  be  a  careless  use  of  language, 
or,  at  best,  a  short-cut  expression  for  a  complicated  act,  to  speak 
of  any  artisan  or  set  of  artisans  as  "making"  anything.  The 
amount  of  matter  in  the  world  is  not  subject  to  man's  control. 
He  cannot  add  to  it  one  atom  or  subtract  one  atom.  All 
that  he  can  do  is  to  change  forms  and  combination.  And  just 
this  he  does  in  production.  He  fashions  and  refashions  material 
things.  He  puts  them  into  forms  in  which  they  serve  his  wants. 
Such  is  obviously  the  nature  of  the  carpenter's  work,  the 
tailor's,  the  cook's.  It  is  not  less  true  of  those  whom  we  de- 
scribe as  "producing  materials."  The  plants  from  which  man 
secures  the  greatest  part  of  his  food  and  most  of  the  materials 
he  uses,  get  their  constituent  parts  from  the  soil  and  the  air. 
What  man  does  is  to  arrange  conditions  favorable  for  their 


18  THE  ORGANIZATION  OF  PRODUCTION 

growth.  The  minerals  which  he  uses  are  a  fixed  store  in  the 
earth's  crust.  When  we  say  that  coal  is  produced,  we  mean 
that  it  is  brought  to  the  surface  and  made  available  for  our 
use. 

The  modes  in  which  man  brings  about  utilities  or  satisfac- 
tions are  many.  Not  only  are  plants  grown,  and  coal,  iron, 
copper  brought  up  from  the  mines;  not  only  are  these  raw 
materials  shaped  and  adapted  for  their  different  uses,  —  they  are 
also  transported  to  the  places,  often  very  distant,  where  they 
reach  the  hands  of  those  whose  wants  they  finally  satisfy. 
They  are  bought  by  traders  from  one  set  of  persons,  and  sold 
again  to  another;  and  among  the  traders  there  is  a  division 
of  labor,  some  buying  at  wholesale  and  selling  again  to  the  re- 
tailers, who  dispose  of  the  commodities  to  their  customers. 
The  phrase  "place  utility"  has  been  used  to  describe  the  con- 
tributions of  those  engaged  in  transportation  and  trade ;  and 
it  serves  to  bring  into  relief  the  fact  that  such  persons,  though 
they  do  not  shape  or  fashion  commodities,  yet  contribute  to 
their  utilization. 

Now,  since  the  essence  of  production  is  that  it  leads  to  satis- 
factions or  utilities,  it  follows  that  any  labor  or  effort  that 
yields  utilities  is  productive.  The  musician  whose  performance 
brings  us  pleasure  does  precisely  the  same  sort  of  thing  as  the 
florist  whose  blossoms  last  a  few  hours.  The  domestic  servant 
contributes  to  our  ease  just  as  does  the  artisan  who  supplies 
the  furniture  for  our  dwellings.  No  doubt  there  are  gradations 
in  the  importance  of  the  wants  supplied  by  different  workers. 
The  essentials  of  life  are  most  important;  the  conveniences  and 
luxuries  come  after  them ;  and  these  gradations,  as  we  shall  see, 
have  economic  consequences.  But  they  are  not  significant  for 
our  present  purpose;  they  give  no  ground  for  distinguishing 
between  those  producers  who  embody  utilities  in  material 
objects,  and  those  who  do  not.  If  we  were  called  on  to  dispense 
with  the  services  of  some  of  the  producers,  we  might  put  aside, 
as  easily  spared,  first,  the  buffoons  and  the  opera  dancers  who 
figure  as  unproductive  hi  Adam  Smith's  list.  But  we  might 


OF  LABOR  IN  PRODUCTION  19 

also  put  aside  at  once  the  scene  painters  at  the  opera,  the 
printers  of  trashy  books,  the  makers  of  cloying  sweets  and 
noxious  drinks.  And  if,  on  the  other  hand,  we  were  called  on 
to  say  what  producers  we  should  retain  to  the  last,  we  should 
select  not  only  those  who  supply  the  material  things  essential 
for  existence,  —  food,  clothing,  shelter,  —  but  also  the  physician 
who  preserves  our  health  and  the  teacher  who  maintains  the 
education  on  which  rests  civilization.  The  distinction  between 
things  essential  and  things  dispensable  is  by  no  means  the 
same  as  that  between  material  and  immaterial  sources  of 
utilities. 

We  conclude,  then,  that  all  those  whose  labors  satisfy  wants 
—  all  those  who  bring  about  satisfactions  or  utilities  —  are 
to  be  reckoned  as  taking  part  in  production,  and  are  to  be 
called  productive  laborers.  Certain  it  is,  whatever  phraseology 
we  care  to  apply,  that  no  conclusions  of  importance  for  economics 
flow  from  the  distinction  between  those  who  shape  material 
wealth  and  those  who  bring  about  utilities  of  other  kinds.  And 
the  test  of  the  value  of  a  distinction  or  classification  is  always 
that  significant  propositions  can  be  laid  down  as  to  the  things 
put  into  a  given  class  which  do  not  hold  for  those  outside 
the  class. 

This  conclusion  also  enables  us  to  dispose  of  an  allied  question : 
Is  there  nonmaterial  wealth  ?  Those  who  denied  the  old  prop- 
osition, —  who  maintained  that  labor  which  did  not  embody 
a  utility  in  material  objects  was  nevertheless  productive  — 
often  maintained  that  there  was  such  a  thing  as  "nonmate- 
rial "  wealth.  The  phrase  certainly  is  not  in  accord  with  com- 
mon usage.  We  think  ordinarily  of  wealth  as  something  that 
can  be  kept  and  accumulated,  and  intend  by  it  tangible  things ; 
and  hi  this  sense  it  is  a  contradiction  in  terms  to  speak  of  im- 
material wealth.  But  if  we  use  the  more  technical  and  there- 
fore more  precise  phrase,  "economic  goods,"  we  include  all  those 
things  and  services  which  satisfy  human  wants  and  are  not  to 
be  had  free.  Services  of  those  whom  Adam  Smith  and  his 
followers  called  unproductive  laborers  come  under  this  head. 


20  THE  ORGANIZATION  OF  PRODUCTION 

They  are  desired  and  prized,  often  highly  prized ;  and  they  are 
yielded  by  human  effort.  The  rewards  earned  by  these  efforts 
are  an  important  topic  in  economic  science,  and  the  utilities 
provided  are  an  important  part  of  the  sum  of  utilities  which 
constitute,  in  the  last  analysis,  the  community's  income.  If 
we  mean  by  wealth  anything  about  which  economic  problems 
arise,  we  must  make  the  term  coextensive  with  the  term  "  eco- 
nomic goods  " ;  and  then  we  may  speak  of  nonmaterial  wealth. 

§  3.  From  this  interpretation  of  the  terms,  it  would  seem 
to  follow  that  all  labor  belongs  to  the  productive  class.  If  not 
only  the  butcher  and  the  baker  are  in  this  class,  but  the  barber 
and  the  fiddler,  do  any  remain  who  are  to  be  regarded  as 
unproductive  ? 

Obviously,  there  are  some  persons  who  are  outside  the  pale 
of  productive  activity.  The  paupers,  thieves,  swindlers, 
ne'er-do-wells,  are  parasites.  Thieves  and  swindlers  often 
exert  themselves  severely,  though  not  often  continuously.  But 
their  activity  is  purely  predatory.  They  contribute  nothing; 
they  simply  try  to  get  things  away  from  others.  Whether  or 
no  we  should  apply  the  term  "labor"  to  their  exertions,  it  is 
certainly  not  to  be  called  productive  labor. 

A  different  question  arises  as  to  some  labor  carried  on  without 
violation  of  the  law  and  without  conscious  delinquency,  yet 
certainly  of  doubtful  aspect.  A  quack  medicine,  containing 
ingredients  which  the  maker  knows  to  be  noxious,  or  at  best 
harmless,  may  be  puffed  by  mendacious  advertising  into  wide- 
spread use.  Can  it  be  said  that  the  labor  devoted  to  preparing 
it  and  persistently  circulating  lies  about  it  is  productive  of 
satisfactions,  and  therefore  to  be  reckoned  as  productive  labor  ? 

To  take  another  case,  of  still  a  different  sort,  what  shall  we 
say  of  the  labor  given  in  well-nigh  all  communities  to  the  pro- 
duction and  sale  of  intoxicating  liquors  ?  Among  physiologists 
the  settled  conclusion  is  that,  though  the  use  of  these  stimulants 
in  the  lighter  forms  may  lead  to  no  serious  harm,  that  of  dis- 
tilled spirits  is  overwhelmingly  bad.  It  is  certain  that  an 
immense  amount  of  misery  and  vice  comes  from  the  widespread 


OF  LABOR  IN  PRODUCTION  21 

use  of  strong  liquors ;  that  the  diminution  in  their  consump- 
tion during  the  last  generation  or  two  has  brought  better- 
ment for  mankind;  and  that  the  world  would  be  a  much 
happier  place  if  drunkenness  could  be  stamped  out.  What 
has  the  economist  to  say  of  labor  given  to  the  production  of 
things  harmful  ? 

These  cases  call  for  discrimination.  They  may  be  cases  of 
fraud  and  deceit.  They  may  be  cases  of  wants  misdirected, 
but  none  the  less  wants  really  felt  and  really  satisfied. 

Fraud  and  deceit  mean  that  a  person  does  not  secure  that 
which  he  expected  and  was  led  to  expect.  In  an  ordinary  sale, 
the  seller  is  not  presumed  by  the  law  to  give  a  guarantee  as  to 
the  quality  of  the  thing  sold:  caveat  emptor.  But  where  a 
guarantee  is  given,  or  a  precise  description  equivalent  to  a 
guarantee,  the  buyer  has  a  remedy  in  the  courts. 

The  distinction  made  by  the  law  is  substantially  that 
which  the  economist  would  make.  The  quack  medicine  may 
be  a  draft  of  flavored  water  or  disguised  alcohol.  But  so 
long  as  the  purchaser  wants  this  sort  of  thing,  and  buys]  be- 
cause he  has  a  notion  it  will  do  him  good,  the  purveyor  adds 
to  the  sum  of  satisfactions.  The  case  is  different  where  the 
purchaser  wants  one  thing,  and  is  deceived  into  taking  some- 
thing else ;  since  then  his  felt  wants  are  not  satisfied.  Inter- 
mediate is  the  case  where  the  purchaser  does  not  know  precisely 
what  he  wants,  and  is  wheedled  into  taking  something  which 
the  other  man  wants  to  sell.  Here  it  is  often  difficult  to  draw 
the  line.  Is  the  buyer  foolish,  or  is  he  swindled  ?  Does  the 
seller  lie  outright,  or  is  he  merely  expansive  in  praise  of  his  wares  ? 
What  the  law  can  do  is  to  aid  in  making  the  situation  clear; 
and  this  is  particularly  needful  where  the  consequences  of  mis- 
understanding are  serious.  Hence  the  pure-food  and  pure-drug 
legislation,  and  the  legislation  requiring  that  the  composition  of 
nostrums  be  precisely  stated  on  their  labels. 

Where  the  want  is  really  felt  and  really  satisfied,  the  labor  that 
brings  satisfaction  must  be  adjudged  by  the  economist  produc- 
tive ;  and  this,  even  though  the  ultimate  consequences  be  harmful 


22  THE  ORGANIZATION  OF  PRODUCTION 

The  keeper  of  a  dramshop  is  a  productive  laborer,  even  though 
he  purveys  something  which  often  causes  misery.  To  enter 
on  inquiries  about  the  final  effect  on  human  welfare  would  raise 
many  questions  of  a  different  sort  from  those  within  the  strict 
range  of  economics;  inquiries  which,  if  consistently  followed 
in  all  cases,  would  range  into  almost  every  field  of  knowledge. 
There  are  physiologists  who  believe  that  meat,  though  men  like 
it,  is  unnecessary  for  nourishment  and  is  frequently  a  cause  of 
disease.  Others  maintain  that  such  stimulants  as  tea  and 
coffee  are  of  ill  effect ;  that  health  and  happiness  are  promoted 
by  abstinence  from  them.  To  judge  between  these  various 
advocates  and  reformers  is  no  part  of  the  essential  task  of 
the  economist.  So  long  as  a  person  who  buys  a  thing  or  pays 
for  a  service  really  desires  it,  the  labor  which  yields  him  the 
satisfaction  is  productive.  The  economist  is  concerned  to  in- 
quire what  labor  is  productive  in  this  sense  and  what  is  not, 
and  what  are  the  various  aspects  and  consequences  of  men's 
activities  in  trying  to  satisfy  their  wants. 

A  case  which  may  call  for  nice  distinction  between  labor  that 
is  productive,  even  though  morally  questionable,  and  labor  that 
is  predatory,  is  that  of  the  professional  gambler.  For  example, 
those  who  maintain  the  luxurious  establishment  at  Monte  Carlo 
may  be  regarded,  on  the  one  hand,  as  simply  purveying  to  that 
love  of  games  of  chance  which  is  so  universal  as  almost  to  be 
classed  as  instinct.  So  far  as  they  do  so  —  so  far  as  the  act  of 
gaming  is  pleasurable  to  their  customers  —  they  supply  a  satis- 
faction, even  though  it  may  be  desirable  for  permanent  welfare 
that  this  craving  be  kept  in  check.  On  the  other  hand,  so  far 
as  both  parties  —  croupier  and  gamester  —  are  merely  trying  to 
get  each  other's  money,  and  care  not  for  the  play  per  se,  the 
activities  of  both  are  predatory.  Just  what  motive  underlies 
the  gamester's  wagers  may  be  a  matter  for  nice  psychological 
analysis.  No  doubt  the  two  distinguishable  motives  —  love 
of  play  and  cupidity  for  the  other  man's  money  —  are  often 
combined.  There  are  certainly  instances  enough  where  the 
pleasure  of  the  play  counts  for  nothing,  and  where  cupidity 


OF  LABOR  IN  PRODUCTION  23 

alone  is  at  work ;  and  then  the  keeper  of  the  gambling  estab- 
lishment is  simply  predatory. 

Returning  now  to  such  articles  as  were  considered  a  moment 
ago  —  drugs  and  alcoholic  spirits,  whose  effects  may  be  noxious 
—  we  may  note  the  obvious  distinction  between  saying  that  a 
given  kind  of  labor  is  productive  and  saying  that  it  ought  to  be 
exercised.  Though  a  want  may  be  satisfied  by  the  labor,  it  does 
not  follow  that  happiness,  or  the  best  kind  of  happiness,  is 
promoted  thereby.  The  law  may  prohibit  gambling,  or  the 
manufacture  and  sale  of  liquor,  because  it  is  thought  best  that 
men  should  not  have  the  gratifications  at  all.  Whether  or  no 
a  prohibition  of  this  kind  should  be  enacted  raises  questions, 
to  repeat,  of  very  wide  range,  to  whose  solution  the  economist 
can  doubtless  contribute,  but  on  which  he  says  by  no  means 
the  final  word.  The  labor  which  yields  a  service  may  be,  in 
the  eye  of  the  economist,  strictly  productive;  but  it  may  be 
a  kind  of  productive  labor  which  had  better  not  be  exercised. 

§  4.  The  meaning  which  we  affix  to  the  word  "  productive" 
is  further  illustrated  by  one  of  those  professions  which  Adam 
Smith  regarded  as  indeed  grave  and  important,  but  none  the 
less  unproductive,  —  the  law.  With  the  lawyer  may  be  grouped 
the  judge,  the  policeman,  the  jailer,  —  all  those  concerned  with 
the  administration  of  the  law.  In  a  sense,  their  services  are 
not  necessary.  They  do  not  conduce  directly  to  the  production 
of  material  goods  or  to  the  rendering  of  services  or  utilities  to 
consumers.  They  are  inevitable  adjuncts  to  the  processes  of 
production,  rather  than  immediately  contributing  factors.  If 
all  men  were  honest,  truthful,  fair-minded,  and  willing  to  abide 
at  once  by  the  decision  of  an  impartial  arbitrator,  the  work 
of  the  legal  profession  and  of  all  its  hangers-on  could  be  dispensed 
with,  or  at  least  reduced  to  insignificant  dimensions.  If  virtue 
were  universal,  policemen  and  jailers  would  disappear,  and 
lawyers  would  have  little  or  nothing  to  do.  Yet  the  experience 
of  all  peoples  shows  that  —  men  being  what  they  are  —  the 
work  of  the  legal  profession  becomes  indispensable  in  any  com- 
plex society.  As  property  is  accumulated  and  diversified,  as 


24  THE  ORGANIZATION  OF  PRODUCTION 

exchanges  between  men  multiply,  as  the  precise  relations  between 
different  persons  come  to  be  carefully  defined  by  law,  the  business 
of  interpreting  the  complex  system  is  put  into  the  hands  of  a 
separate  profession.  The  settlement  of  differences  is  intrusted 
to  judges;  the  orderly  conduct  of  affairs  is  aided  by  the  advice 
of  lawyers;  the  observance  of  the  law  is  enforced  by  the  police. 
No  doubt  an  ill-devised  legal  system  entails  more  labor  of  this 
sort  than  would  suffice  under  a  better  system;  and  the  un- 
prejudiced observer  must  question  whether  the  law  of  our 
modern  communities  works  as  efficiently  as  it  might.  But 
a  clumsy  instrument,  though  it  involves  more  labor  than  one 
well  adjusted,  is  none  the  less  useful. 

Similar  considerations  apply  to  the  army  and  navy.  The 
immediate  object  of  the  soldier's  work  is  destruction.  He  must 
be  supported  by  the  rest  of  the  community;  he  does  not  con- 
tribute directly  to  its  well-being.  Yet  military  protection  has 
been,  through  almost  all  history,  an  indispensable  condition  for 
the  sustained  conduct  of  peaceful  industry.  Like  the  police- 
man, the  soldier  is  needed  because  of  the  bad  passions  of 
man.  And  even  where  defense  is  not  necessary,  and  armaments 
are  maintained  from  national  vanity  or  senseless  rivalry,  the 
soldier  nevertheless  must  be  reckoned  productive  in  the  sense 
that  he  does  what  people  wish  to  have  done  and  what  they 
pay  him  for.  The  army  and  navy  may  be  only  dangerous 
playthings.  But  men  are  not  less  foolish  when  they  pay  for 
tawdry  ornament  or  vulgar  amusement.  It  is  not  for  the 
economist  to  sit  in  judgment  on  then-  tastes. 

There  is  indeed  a  situation  in  which  a  military  force  is,  from 
the  economist's  point  of  view,  clearly  unproductive.  This  is 
where  it  is  used  solely  and  simply  for  aggression.  A  pirate  is 
obviously  not  a  productive  laborer.  Unfortunately  many  of 
the  heroes  of  history  have  been  no  better  than  pirates.  The 
armies  of  the  first  Napoleon  swarmed  over  Europe,  levying 
tribute  wherever  they  penetrated.  No  doubt  deep-lying  his- 
torical forces  served  to  bring  on  the  wars  of  the  Napoleonic 
period.  Some  conflict  was  inevitable  between  the  old  feudal 


OF  LABOR  IN  PRODUCTION  25 

order  of  society  and  that  new  order  which  arose  with  the  French 
Revolution.  But  the  domineering  spirit  of  Napoleon  turned  the 
conflict  in  its  later  stages  to  mere  aggression  on  the  one  side,  ex- 
hausting defense  against  aggression  on  the  other.  That  defense 
was  necessary;  yet  all  the  effort  applied  both  to  offense  and 
defense  was  in  the  last  analysis  a  fruitless  application  of  labor. 

Lest  this  mode  of  considering  the  military  be  judged  shallow 
by  some  of  our  fellow  economists,  — it  is  likely  to  be  so  regarded 
by  many  Germans,  in  whose  contemporary  civilization  prepara- 
tion for  war  plays  so  large  a  part,  — let  it  be  added  that  the  bare 
economic  side  of  the  matter  is  not  the  only  one  to  be  considered. 
Complex  political  and  social  questions  present  themselves,  quite 
beyond  the  scope  of  a  book  on  economics.  No  range  of  top- 
ics brings  out  more  clearly  the  need  of  considering  problems 
that  are  partly  economic  from  other  points  of  view  as  well. 
Even  as  a  problem  in  economics  alone,  the  industrial  progress 
of  mankind  has  often  proceeded  in  strange  ways.  Civilization 
has  gone  forward  on  the  powder  cart,  as  in  our  Civil  War.  Ag- 
gression itself  sometimes  leads  to  happier  ends.  The  English 
first  took  possession  of  India  in  a  spirit  of  sheer  rapacity.  Yet 
their  rule,  resting  as  it  still  does  on  force,  has  much  promoted 
the  material  welfare  of  the  native  races.  And  hi  the  conflicts 
between  civilized  peoples  also,  whatever  their  origin,  a  better 
order  and  a  higher  prosperity  have  often  emerged  from  wars 
that  were  seemingly  causeless.  Reflections  of  this  sort  will 
occur  to  every  thoughtful  reader,  and  lead  him  to  qualify  and 
interpret  what  has  here  been  said  of  the  relating  of  armaments 
and  wars  to  the  principle  which  underlies  the  conception  of 
productive  labor. 

§  5.  There  remain  to  be  considered  questions  as  to  the  re- 
lations of  certain  kinds  of  activity  to  the  productiveness  of  labor. 
Are  any  of  the  business  doings  which  go  on  in  modern  society 
to  be  judged  unproductive? 

When  unscrupulous  persons  solicit  funds  from  the  gullible, 
ostensibly  for  "investment"  or  "speculation,"  and  in  due  time 
run  off  with  the  money,  their  labor,  systematic  and  strenuous 


26  THE  ORGANIZATION  OF  PRODUCTION 

though  it  may  be,  is  obviously  predatory.  Not  only  they,  but  the 
clerks  and  assistants  whom  they  employ  (whether  these  be 
accomplices  or  innocent),  are  unproductive.  Now  it  is  main- 
tained that,  outside  the  range  of  operations  so  clearly  predatory 
as  to  be  made  criminal  by  law,  there  are  not  a  few  others,  within 
the  pale  of  the  law,  whose  economic  effect  is  substantially  the 
same.  This  is  alleged,  to  take  a  familiar  example,  of  speculative 
transactions  in  general.  In  our  highly  organized  modern  com- 
munities, an  immense  amount  of  buying  and  selling  is  done  for 
a  turn  in  the  market.  A  man  buys  wheat  or  cotton  which  he 
does  not  want  and  which  never  gets  into  his  possession;  he 
promptly  sells  his  nominal  title  at  an  advance  in  price,  pocketing 
what  is  called  a  profit.  Is  any  contribution  made  to  the  sum 
of  utilities  by  such  transactions  ?  It  may  be  assumed  that  the 
pleasure  of  the  game,  which  may  be  an  element  in  gambling 
with  cards  or  dice,  here  plays  but  a  negligible  part;  the  motive 
is  simply  to  get  gain  somehow.  The  most  conspicuous  opera- 
tions of  the  sort  are  on  the  stock  exchange,  where  sales  and 
purchases  take  place  on  an  enormous  scale  with  no  traceable 
effect  in  adding  to  production  or  to  social  income.  The  business 
involves  an  elaborate  apparatus,  —  brokers,  clerks,  officers,  a 
periodical  press  of  its  own.  As  the  clerks  of  a  bare  swindler  are 
unproductive,  so  must  be  those  of  the  broker,  if  he  is  himself 
in  the  parasitic  class. 

But  this  sort  of  allegation  has  been  pushed  further.  A  large 
part  of  what  is  ordinarily  called  "  business  "  has  been  placed 
under  the  same  ban.  Not  only  those  who  are  usually  called 
speculators,  but  those  who  "operate"  in  real  estate  —  buy  and 
sell  land  for  a  margin  of  profit  —  and  the  bankers  who  "handle" 
stocks  and  bonds  are  described  as  mere  parasites.  Nay,  all 
business  men,  of  every  kind,  have  been  condemned  by  socialist 
writers  as  essentially  unproductive,  —  that  is,  so  far  as  they 
are  not  directly  doing  work  of  management  and  superintendence. 
By  them" business"  has  been  adjudged,  simply  a  way  of  secur- 
ing a  gain  through  the  ignorance  or  weakness  of  others,  and 
therefore  to  be  condemned  as  useless  to  society. 


OF  LABOR  IN  PRODUCTION  27 

The  questions  here  raised  cannot  be  answered  until  after  a 
consideration  of  some  very  complex  matters.  But  the  mode  in 
which  they  should  be  dealt  with  and  the  nature  of  the  answers 
to  be  sought  can  be  indicated  now,  even  though  with  some  antici- 
pation of  later  conclusions.  Thus,  as  regards  one  of  the  set  of 
operations  supposed  to  be  unproductive,— speculative  dealings, 
—  it  must  be  admitted  that  the  charge  is  in  part  founded.  Though 
some  speculative  dealings  in  commodities  and  securities  serve 
a  useful  purpose,  others  are  in  large  part  mere  wagers,  akin  in 
their  economic  effect  to  vulgar  gambling.1  Judged  by  the  test 
which  we  have  set  up, — whether  the  labor  adds  to  the  sum  of 
utilities, — all  those  who  engage  in  mere  wagering  speculation 
are  unproductive  laborers :  not  only  the  principals,  but  the 
brokers  who  execute  their  orders,  the  clerks  who  record  them, 
the  mechanics  who  put  together  and  operate  the  "  ticker  "  in 
the  broker's  quarters.  All  belong  in  the  class  whose  work 
serves  no  useful  end. 

The  same  test  is  to  be  applied  to  the  activity  of  business 
men ;  but  here  the  balance  of  gain  is  much  clearer.  Though  the 
greater  part  of  speculative  dealings  is  probably  of  no  utility, 
the  greater  part  of  business  men's  doings  has  great  utility.  The 
indictment  of  the  socialists,  which  charges  that  they  are  pre- 
dominantly unproductive,  far  overshoots  the  mark.  The  func- 
tion of  the  manager  or  leader  of  industry  is  of  high  service  in 
production.  He  adds  conspicuously  to  the  abundance  of  com- 
modities and  the  satisfaction  of  wants.  But  it  is  none  the  less 
true  that  in  any  large  center  of  industry  there  will  be  found 
plenty  of  persons  engaged  in  "business"  whose  doings  are  es- 
sentially parasitic.  They  pick  up  a  living,  perhaps  a  very 
comfortable  one,  by  shreds  and  patches  of  dealings,  by  shrewd- 
ness in  buying  and  selling,  by  waiting  for  land  or  securities  to 
rise  in  value.  Often  they  are  sober,  solid  citizens,  personally 
estimable ;  so  indeed  are,  as  a  rule,  the  stockbrokers  who  pro- 
vide the  facilities  for  the  gambling  speculators.  These  respect- 
able persons  would  resent  with  indignation  the  suggestion  that 

'Compare  Book  II,  Chapter  11. 


28  THE  ORGANIZATION  OF  PRODUCTION 

they  belong  in  the  predatory  and  parasitic  class.  But  one  of 
the  most  remarkable  phenomena  presented  to  the  student  of 
economics  is  the  ignorance  of  all  sorts  of  persons  as  to  their  place 
and  function  in  the  industrial  world.  The  broker  or  merchant, 
no  less  than  the  mechanic  or  clerk,  sees  the  little  corner  in  which 
he  is  at  work,  and  knows  nothing  of  its  relations  to  the  com- 
munity as  a  whole.  The  respectability  of  an  employment,  and 
even  the  spirit  in  which  it  is  pursued,  give  no  certain  clew  to  its 
effect  on  the  general  welfare. 

It  is  the  aim  of  the  legal  system  under  which  we  live  —  the 
system  of  private  property  —  to  inhibit  predatory  doings. 
Hence  not  only  physical  violence,  but  fraud  and  deceit,  are  for- 
bidden and  punished.  This  aim  of  the  law  is  in  the  main  at- 
tained. He  who  earns  his  living  in  a  lawful  manner  commonly 
contributes  to  the  sum  total  of  satisfactions.  He  does  what 
another  person  is  willing  to  pay  him  for ;  or,  in  the  more  tech- 
nical language  of  economics,  he  brings  forth  utilities,  and  so 
is  a  productive  laborer.  The  view,  sanctioned  more  or  less 
explicitly  by  some  socialist  writers,  according  to  which  the  work 
of  manual  laborers  alone  is  productive,  and  all  the  income-earning 
and  money-making  of  the  well-to-do  classes  are  unproductive, 
carries  the  indictment  against  the  existing  system  too  far.  But 
the  fact  that  criticism  against  the  working  of  private  property 
is  exaggerated  should  not  blind  us  to  the  fact  that  there  exist 
opportunities  for  securing  an  income  or  even  amassing  a  for- 
tune, not  beyond  the  pale  of  the  law,  yet  of  a  kind  which  the 
economist  must  regard  as  predatory,  and  so  unproductive. 

Some  opportunities  of  this  kind  are  due  to  imperfections  in 
the  law  as  it  stands.  With  changes  in  economic  conditions,  pro- 
ceedings that  once  seemed  helpful  to  the  promotion  of  the  gen- 
eral welfare,  and  perhaps  at  one  stage  were  helpful,  cease  to  be 
so,  or  remain  so  only  in  part.  Thus  joint  stock  companies,  or 
corporations,  have  proved  a  device  of  great  efficacy  in  further- 
ing improvements  in  the  arts  and  in  securing  more  abundant 
and  varied  production.  On  the  other  hand,  the  statutes  under 
which  corporations  may  be  organized,  especially  in  our  American 


OF  LABOR  IN  PRODUCTION  29 

states,  have  often  made  possible  precisely  that  evil  of  which 
the  socialist  critics  complain :  mere  thimblerigging  and  plunder- 
ing. The  reform  of  the  laws  of  incorporation  in  such  a  manner 
as  to  keep  the  good  and  reject  the  evil  is  now  one  of  the  pressing 
problems  in  the  United  States. 

To  discriminate  clearly  between  the  operations  that  are  in  the 
end  helpful  toward  satisfying  wants,  and  those  that  are  not, 
is  sometimes  impossible  even  after  the  nicest  weighing  of  the 
results  by  the  best  judges.  The  law,  for  instance,  withholds 
its  sanction  from  mere  wagering  contracts.  Yet  transactions 
which  are  wagers  cannot  be  distinguished  in  outward  form  from 
others  which  are  useful  to  society.  There  is  a  vague  con- 
sciousness in  the  public  mind  that  some  persons  are  engaged  in 
"legitimate"  business,  while  others  doing  the  same  sort  of  thing, 
"illegitimately"  occupied,  are  "plungers."  But  to  draw  a  pre- 
cise line  between  those  that  may  be  approved  and  those  that 
may  not,  is  no  less  difficult  for  the  business  man,  however  in- 
telligent and  wide-minded,  than  for  the  judge  or  the  economist. 
So  it  is  with  the  law  of  fraud  and  deceit.  As  long  as  men  are 
free  to  choose  for  themselves  and  act  according  to  their  own 
judgments,  those  who  are  shrewd  and  watchful  will  make 
better  bargains  than  those  who  are  dull  and  unobservant.  When 
does  one  man  overreach  another,  when  does  he  simply  leave  him 
to  judge  for  himself  as  to  his  own  interests  ?  The  probabilities 
are  that  for  the  sake  of  securing  the  large  general  benefits  that 
flow  from  private  property  and  competitive  dealings  we  shall 
always  have  to  permit  some  doings  that  are  on  the  line  between 
the  productive  and  the  predatory.  If  the  law  brings  it  about 
that  labor  is  applied  in  the  main  to  the  satisfaction  of  wants ; 
if  it  restrains  most  of  the  unproductive  doings;  if  the  system 
as  a  whole  works  well,  and  these  predatory  operations  are  only 
its  loose  ends,  —  it  will  be  better  to  accept  them  as  inevitable 
and  to  set  off  against  them  the  general  benefits.  Absolute  per- 
fection in  human  arrangements  is  not  to  be  looked  for. 


CHAPTER   3 

THE  DIVISION  OP  LABOR  AND  THE  DEVELOPMENT  OF 

MODERN  INDUSTRY 

I 

§  1.  The  division  of  labor  is  one  of  the  great  central  facts  in 
modem  society.  Some  of  the  most  difficult  questions  of  eco- 
nomic theory,  the  most  common  popular  fallacies,  the  most 
serious  problems  of  legislation,  have  their  roots  in  the  division 
of  labor. 

The  division  of  labor  may  be  analyzed  under  two  heads.  On 
the  one  hand  there  is  the  simpler  form,  under  which  a  workman 
carries  through  the  whole  of  one  of  the  stages  in  production. 
The  tailor,  the  cobbler,  the  carpenter,  ply  their  several  trades. 
On  the  other  hand  there  is  the  more  complex  form,  under 
which  there  is  a  splitting  up  of  several  operations  all  belonging 
to  one  stage  of  production.  In  more  primitive  stages  of  in- 
dustry the  shoemaker  might  be  a  tanner,  and  the  whole  process 
of  converting  the  rawhide  into  a  shoe  thus  be  in  one  hand. 
Nowadays,  the  shoe  itself  is  not  put  together  by  the  cobbler; 
it  is  the  work  of  a  large  number  of  different  workmen  in  a 
factory,  of  whom  some  do  nothing  but  cut  the  leather,  others 
stitch  it,  others  put  on  the  soles,  still  others  the  heels,  and  so 
on,  with  an  elaborated  parceling  of  different  operations. 

Obviously,  a  hard-and-fast  line  cannot  be  drawn  between 
these  two  aspects  of  the  division  of  labor.  No  craftsman  carries 
through  from  beginning  to  end  any  one  operation  in  produc- 
tion. The  tailor  buys  his  materials  of  the  .cloth  maker;  the 
cloth  maker  buys  his  wool  of  the  farmer  or  grazier.  The  cloth 
maker  and  the  grazier  in  turn  buy  tools  of  the  mechanic,  who 
buys  materials  from  the  ironworker  and  woodworker.  On 
the  other  hand,  the  tailor  does  not  necessarily  carry  his  own 
work  through  even  the  whole  of  the  stage  with  which  he  is 

30 


THE  DIVISION  OF  LABOR  31 

concerned.  It  may  be  divided  between  the  cutter  and  the 
stitcher ;  and  similarly  the  cloth  maker's  may  be  parceled  out 
between  the  weaver,  the  fuller,  the  dyer.  The  difference  be- 
tween the  simpler  and  the  more  complex  division  of  labor  is 
essentially  one  of  degree.  Nevertheless,  this  difference  of 
degree  is  important.  The  two  sorts  of  arrangement  bring  about 
somewhat  different  advantages  and  give  rise  to  different  social 
conditions. 

§  2.  Let  us  consider  first  the  simpler  division  of  labor. 
This  dates  far  back  into  antiquity.  The  familiar  crafts  are 
of  very  old  standing.  The  extent  to  which  their  names  have 
been  adopted  as  surnames  shows  how,  among  modern  peoples, 
occupations  were  separated  in  that  comparatively  simple  state 
of  society,  in  the  Middle  Ages,  when  patronymics  were  in  pro- 
cess of  formation.  The  Carpenters,  Masons,  Smiths,  Weavers, 
Drapers,  Tailors,  Dyers,  Saddlers,  Shoemakers,  Millers,  Bakers, 
Coopers,  and  such  other  common  surnames  indicate  what  sort 
of  division  of  labor  was  maintained  for  hundreds  of  years  with 
comparatively  little  change. 

The  chief  advantage  in  production  from  this  form  of  the 
division  of  labor  is  the  gain  in  dexterity  which  comes  from  the 
constant  practise  of  the  same  occupation.  So  familiar  are  we 
with  the  effect  of  practise  that  we  assume  as  a  matter  of  course 
the  skill  which  comes  from  it.  Reading,  writing,  the  donning 
of  our  clothes  and  the  lacing  of  our  boots,  are  effected  with  ease, 
almost  without  effort,  from  the  ingrained  effects  of  custom  and 
iteration.  Piano  playing  and  typewriting  are  marvelous  to 
the  inhabituated,  easy  to  the  point  of  indifference  for  the 
practised  hand.  The  acquired  dexterity  of  the  craftsman  and 
mechanic  make  their  productive  capacity  infinitely  greater  than 
they  would  be  if  each  had  to  carry  on  a  dozen  occupations 
and  were  half  proficient  in  any  one. 

Other  gains  also  have  been  enumerated  as  accruing  from  the 
simpler  division  of  labor.  There  is  a  saving  in  time  when  the 
same  task  is  followed  without  interruption.  The  carpenter, 
even  though  no  more  dexterous  than  the  farmer,  can  yet  accom- 


32  THE  ORGANIZATION  OF  PRODUCTION 

plish  more  in  the  hour  or  the  day  than  the  farmer  who  tries  to 
do  jobs  of  tinkering  in  his  spare  moments.  Something  also  is 
due  to  the  adaptation  of  tasks  to  the  abilities  of  the  workers. 
There  are  differences  between  the  inborn  abilities  of  individuals, 
even  as  regards  tasks  for  which  training  and  practise  are  the 
most  important  causes  of  dexterity.  Among  mechanics  a  cer- 
tain proportion  only  have  the  sure  eye  and  the  deft  hand  which 
are  required  for  the  most  exacting  tasks.  It  is  obviously 
advantageous  that  they  should  confine  themselves  chiefly  to 
these,  leaving  the  less  exacting  to  persons  of  ordinary  capacity. 
Even  for  comparatively  simple  occupations  there  are  dif- 
ferences in  the  qualifications  of  individual  workmen.  The 
work  of  a  motorman  on  an  electric  car  seems  of  the  most  mo- 
notonous sort,  easily  accomplished  by  any  adult.  Yet  it  re- 
quires a  certain  steadiness  and  alertness  of  attention  not  pos- 
sessed by  all  laborers.  How  far  differences  of  this  sort  are 
the  result  solely  of  inborn  qualities,  how  far  brought  about  or 
accentuated  by  education  and  environment,  need  not  here  be 
considered.  So  long  as  they  exist,  there  is  a  gain  if  each  indi- 
vidual is  called  on  to  do  only  that  for  which  he  has  the  greatest 
aptitude. 

The  last-mentioned  factor  in  the  division  of  labor  —  the 
adaptation  of  tasks  to  varying  aptitudes — is  of  most  importance 
as  between  those  who  work  with  their  heads  and  those  who 
work  with  their  hands.  Though  there  is  mental  training  as  well 
as  manual  training,  and  though  instruction  and  practise  tell  in 
the  lawyer's  trade  as  well  as  in  the  mechanic's,  inborn  abilities 
are  important  in  greater  degree  for  the  former.  This  is  more 
particularly  the  case  in  all  work  which  calls  for  initiative, 
superintendence,  direction.  There  is  a  difference  of  far-reaching 
effect  between  those  who  have  the  qualities  for  leadership, 
whether  in  the  arts  or  in  intellectual  life,  and  those  who  must 
belong  to  the  rank  and  file.  There  is  often  a  very  great  gain 
when  those  who  are  born  leaders  can  devote  themselves  solely 
to  the  work  which  they  alone  can  do,  or  which  they  can  do 
best,  leaving  to  others,  with  no  such  capacities,  the  routine 
mechanical  or  clerical  work. 


THE  DIVISION  OF  LABOR  33 

The  great  mass  of  men,  however,  have  no  special  aptitudes. 
For  them,  continued  practice,  begun  or  aided  by  systematic 
training,  is  the  chief  cause,  even  though  not  the  only  cause,  oi 
skill  in  any  particular  sort  of  work.  In  the  main,  the  division  of 
labor  is  a  cause  rather  than  a  result  of  specialized  capacity. 
Most  dexterous  men  are  so  because  they  have  long  practised 
a  given  art ;  they  do  not  practise  it  because  they  are  born  with 
dexterity. 

§  3.  Let  us  turn  now  to  what  we  have  styled  the  more  com- 
plex form  of  the  division  of  labor.  This  is  the  salient  charac- 
teristic of  the  development  of  industry  during  the  last  century 
and  a  half;  a  development  which  has  gone  on  with  accelerat- 
ing pace  in  very  recent  times.  The  change  in  industry  and 
the  nature  of  the  new  order  of  things  can  be  described  most 
concisely  by  saying  that  the  tool  has  been  replaced  by  the 
machine. 

Though  the  gain  in  efficiency  from  the  division  of  labor  arises 
chiefly  from  the  dexterity  acquired  by  repetition,  none  of  the 
trades  familiar  under  the  simpler  division  of  labor  was  reduced 
to  the  continuous  repetition  of  identical  movements.  The  car- 
penter, the  mason,  the  smith,  the  tailor,  —  each  was  master 
of  his  trade  as  a  whole,  and,  while  gaining  proficiency  from 
unceasing  practise,  yet  turned  from  one  part  of  the  occupation 
to  another.  The  instruments  which  these  artisans  used  were 
tools,  of  varied  kinds,  adapted  to  the  different  parts  of  their 
occupations.  A  "tool,"  as  that  word  is  still  commonly  used, 
means  a  hand  tool,  put  in  motion  by  human  force  and  requir- 
ing adaptation,  judgment,  flexibility. 

The  gradual  elaboration  of  the  division  of  labor  slowly  en- 
larged the  number  of  occupations,  diminished  the  range  of 
each  one,  and  tended  to  reduce  each  more  and  more  to  an 
identical  routine.  Thus  the  making  of  cloth  was  divided 
between  the  spinner,  the  weaver,  the  fuller,  the  dyer.  The 
division  between  the  spinner  and  the  weaver,  itself  one  of  the 
oldest,  became  eventually  of  much  moment,  for  it  gave  occa- 
sion for  one  of  the  epoch-making  applications  of  machinery 


34  THE  ORGANIZATION  OF  PRODUCTION 

and  power.  When  the  steady  repetition  of  the  same  move- 
ment becomes  an  important  part  of  an  industrial  art,  it  is 
possible  to  apply  other  force  than  that  of  man's  muscles.  No 
machine,  even  in  the  highly  elaborated  forms  of  modern  times, 
can  rival  in  dexterity  and  flexibility  the  human  hand.  But 
whenever  the  same  thing  is  to  be  done  over  and  over,  the  blind 
forces  of  nature,  working  through  a  machine,  can  do  it  as  well 
as  the  human  hand,  and  indeed  better  than  most  human  hands. 
The  division  of  labor  in  its  simpler  form  gradually  was  de- 
veloped to  the  point  where  the  application  of  power  was  pos- 
sible. The  gain  from  the  application  of  power  proved  so  great 
that  there  was  a  reaction  on  the  division  of  labor :  an  induce- 
ment to  split  up  the  steps  in  production  still  further,  to  reduce 
more  and  more  of  them  to  the  repetition  of  identical  movements, 
and  so  to  make  possible  in  still  greater  degree  the  use  of  natural 
forces. 

The  great  change  toward  the  use  of  machines  and  power 
set  in  during  the  second  half  of  the  eighteenth  century.  The 
textile  trades  felt  its  influence  first.  In  1764,  Hargreaves  in- 
vented the  spinning  jenny;  in  1769,  Arkwright  brought  out 
his  rival  spinning  machine ;  in  1779  Crompton  invented  an  appa- 
ratus which  combined  the  devices  of  Hargreaves  and  Arkwright. 
and  brought  the  spinning  machine  to  a  still  further  stage  of 
perfection.  All  three  were  directed  to  the  mechanical  repeti- 
tion of  the  twisting  of  the  fiber;  and  water  power  was  soon 
applied  to  setting  them  in  motion.  Not  long  afterwards,  weav- 
ing was  also  subjected  to  the  same  principles.  The  power 
loom  was  gradually  elaborated,  and  in  the  beginning  of  the 
nineteenth  century  began  to  supplant  steadily  the  hand  loom. 
By  the  close  of  that  century,  the  old-fashioned  weaver's  trade 
had  become,  in  advanced  countries  like  England  and  the  United 
States,  a  thing  of  the  past.  The  textile  material  to  which 
these  inventions  were  first  applied  was  cotton;  for  this  has 
an  even  and  homogeneous  fiber  which  makes  it  most  readily 
available  for  machinery  operated  continuously  at  uniform  speed. 
Wool,  linen,  and  silk,  being  of  less  even  fiber,  were  subjected  to 


THE  DIVISION  OF  LABOR  35 

the  machine  process  later  than  cotton,  through  a  long  series 
of  subsidiary  inventions.  It  has  not  been  until  our  own  day 
that  silk,  the  most  delicate  and  irregular  of  these  fibers,  has 
come  to  be  manipulated  on  a  large  scale  by  power  machinery. 

Water  power  was  used  for  the  textile  manufactures  in  their 
earlier  stages;  but  it  was  soon  supplemented  and  largely  re- 
placed by  the  steam  engine.  The  steam  engine  was  brought 
by  Watt  to  the  stage  of  effective  working  in  1781.  It  was  first 
used  on  a  large  scale  for  the  pumping  of  water  out  of  mines,  — 
an  obvious  case  for  the  application  of  power,  since  it  calls  for 
the  unchanging  performance  of  the  simplest  of  movements.  It 
was  soon  applied  further,  not  only  to  the  textile  industries  and 
to  a  wide  range  of  other  manufactures,  but  to  transportation. 
Steam  was  used  in  navigation'  by  Fulton  on  the  Hudson  River 
in  1807.  An  even  more  important  application  of  steam  to 
transportation  came  when  the  locomotive  was  perfected  by 
Stephenson  in  1830.  This  created  the  modern  railroad,  and, 
as  we  shall  presently  see,  marked  the  beginning  of  a  still  further 
development  of  the  division  of  labor. 

The  series  of  great  inventions  of  which  these  were  the  most 
important,  brought  about  what  is  known  as  the  Industrial 
Revolution,  —  a  change  in  the  arts,  and  a  consequent  change 
in  economic  and  social  conditions,  greater  than  has  appeared 
during  a  like  short  time  in  any  stage  of  human  history.  Its 
fundamental  economic  characteristic  has  been  the  elaboration 
of  the  division  of  labor,  through  the  splitting  up  of  the  stages 
of  production  into  separate  operations,  each  one  of  which  is 
repeated  continuously  and  so  may  be  carried  on  by  the  machine. 
The  carpenter's  sawing,  planing,  joining,  molding,  —  each  of 
these  is  now  done  separately  by  machinery,  usually  in  estab- 
lishments that  tend  steadily  to  become  larger  and  larger  and 
to  subdivide  still  more  the  various  operations  of  the  trade. 
The  cobbler  of  former  days  put  together  a  shoe  by  himself ;  in 
a  modern  factory  the  shoe  goes  through  some  eighty  different 
processes.  So  it  is  with  ironworking,  with  all  the  elaborated 
processes  of  the  textile  industries,  with  printing  and  book- 


36  THE  ORGANIZATION  OF  PRODUCTION 

making,  not  least  with  the  very  making  of  machines  and  tools. 
The  machines  now  used  are  vastly  more  complex  and  more 
efficient  than  was  dreamed  of  in  the  early  stages  of  the  appli- 
cation of  power,  and  have  extended  the  principle  of  the  auto- 
matic repetition  of  identical  movements  to  tasks  long  thought 
too  intricate  to  be  amenable  to  such  methods.  The  work  of 
the  hand  is  not  indeed  superseded ;  the  skillful  workman  and 
the  adaptable  tool  retain  a  large  place  in  industry;  but  the 
range  of  their  work  tends  to  become  more  and  more  restricted. 
Within  each  branch  of  industry,  as  one  stage  after  another  is 
subjected  to  the  machine  process,  the  other  stages  have  a  nar- 
rower and  simpler  range,  in  which  inventive  spirit  constantly 
finds  new  opportunities  for  the  application  of  power.  Thus 
the  character  and  the  working  of  the  division  of  labor  have 
been  profoundly  and  all  but  universally  modified. 

The  essential  gain  from  this  modern  development  of  the 
division  of  labor  has  come  from  the  virtually  unlimited  store 
of  natural  power.  Once  the  identity  of  movement  has  been 
secured,  there  is  no  work  so  heavy,  no  operation  so  delicate, 
but  that  the  machine  can  repeat  it  day  in,  day  out.  Human 
labor  applied  first  to  putting  together  the  machine,  then  to 
guiding  the  natural  forces  that  move  it,  accomplishes  vastly 
more  than  the  same  amount  of  labor  applied  to  the  making 
and  using  of  the  simpler  tools  of  former  days.  Coal  and  fall- 
ing water  are  the  great  sources  of  power;  and  though  nature 
does  not  supply  them  without  limit,  the  application  of  ma- 
chinery has  not  yet  been  fettered  for  human  needs  by  any  limi- 
tation, nor  is  it  likely  to  be  fettered  in  the  future,  as  far  as  we 
can  look  forward  into  it.  The  labor  required  for  any  one 
operation  in  production  has  been  immensely  lessened  by  the 
industrial  changes  of  the  last  century,  and  appears  likely  to 
be  lessened  no  less  rapidly  and  largely  in  the  century  before 
us. 

The  period  in  which  we  live  has  been  aptly  called  the  age  of 
machinery.  Its  characteristic  phenomena  are  mainly  the 
results  of  the  use  of  machinery;  and  they  will  engage  our 


THE  DIVISION  OF  LABOR  37 

attention  in  many  parts  of  our  subject.  They  are  seen  in  the 
growth  of  capital,  and  the  increasing  power  and  importance  of 
the  business  man  who  has  control  of  capital;  in  the  spread  of 
production  on  a  large  scale,  and  the  tendency  to  monopoly  in 
many  branches  of  industry ;  in  a  new  position  of  the  workmen, 
a  wider  gap  between  employers  and  employees,  and  a  conse- 
quent development  both  of  labor  organizations  and  of  employers' 
associations;  in  grave  social  problems  from  the  employment 
of  women  and  children  in  factories;  not  least,  in  a  loss  of 
individuality  in  the  working  population,  and  a  strengthening 
of  the  lines  of  demarcation  between  social  classes.  Of  all 
these  consequences  of  the  complex  division  of  labor  more  will 
be  said  as  we  proceed. 

§  4.  The  division  of  labor  obviously  means  that  the  persons 
who  carry  on  the  several  operations  of  a  given  branch  of  in- 
dustry combine  to  bring  about  the  final  result.  It  means,  no 
less  clearly,  that  those  engaged  in  different  industries  combine 
to  satisfy  the  varied  wants  of  the  community.  Each  contrib- 
utes his  special  product  to  be  used  by  all;  each  uses  the  prod- 
ucts contributed  by  the  rest.  The  division  of  labor  may  thus 
be  described  also  as  the  combination  or  cooperation  of  labor. 

That  combination  may  conceivably  be  carried  out  deliber- 
ately, with  conscious  control  and  coordination,  with  immediate 
sharing  of  the  joint  output,  and  without  exchange.  In  the 
ancient  civilizations  of  Greece  and  of  Rome  we  get  glimpses  of 
establishments  of  the  rich  and  privileged  in  which  the  several 
trades  are  plied  by  slaves  for  the  benefit  of  the  whole  house- 
hold. In  the  earlier  Middle  Ages,  also,  we  find  seigniorial 
possessions,  where  the  serfs  have  specialized  occupations,  and  con- 
tribute in  kind  to  the  lord's  needs.  Even  in  modern  times,  we 
have  examples  of  communistic  societies,  in  which  there  is  a 
division  of  labor  among  the  individual  members,  yet  no  ex- 
change; each  member  contributing  his  part  to  the  common 
income  and  each  receiving  from  that  income  a  share  deemed 
equitable.  Such  a  society  does  not  approach  so  nearly  to  self- 
sufficiency  as  the  ancient  household  or  the  medieval  estate; 


38  THE  ORGANIZATION  OF  PRODUCTION 

it  must  buy  and  sell  on  a  considerable  scale  with  the  outside 
world,  whereas  those  earlier  organizations  bought  very  few 
things  (salt  and  iron,  for  example).  Yet  within  its  own  limits 
the  division  of  labor  leads  to  no  exchange  between  members. 

Commonly,  however,  the  division  of  labor  has  brought  with 
it  as  a  natural  corollary  the  exchange  of  the  several  commodi- 
ties produced  by  different  workers.  The  cases  noted  in  the 
preceding  paragraph  are  comparatively  rare  in  economic  his- 
tory ;  at  all  events,  they  give  no  clew  to  the  phenomena  of  the 
modern  industrial  world.  There  the  division  of  labor  almost 
always  means  exchange,  and  the  relation  between  the  workers 
is  very  different  from  that  in  a  community  where  there  is  con- 
scious and  deliberate  combination  of  effort.  It  is  strictly  true 
that  the  workers  in  a  modern  society  combine  in  bringing 
about  a  joint  output;  but  the  consciousness  of  cooperation 
is  lost.  The  individual  is  not  thinking  of  the  joint  output. 
Only  if  he  happens  to  be  versed  in  the  books  and  theories  of 
economic  writers,  and  bears  them  in  mind  in  his  active  hours, 
is  he  aware  that  he  is  carrying  on  one  small  operation  toward 
a  joint  output  and  shares  in  the  manifold  contribution  which 
others  make  to  that  joint  output.  The  things  on  which  he 
works  are  not  part  of  a  common  store,  but  are  private  property, 
bought  and  sold,  cared  for  and  guarded,  by  each  individual  for 
himself.  He  thinks  only  of  the  particular  product  which  he 
sells,  and  of  the  terms  on  which  he  can  buy  other  products. 
He  is  intent  on  the  results  of  the  exchange  thus  made,  and  tries 
to  secure  for  himself  the  best  terms  of  exchange.  Private 
property  and  exchange  are  well-nigh  universally  the  conse- 
quences of  the  division  of  labor,  and  the  phenomena  of  ex- 
change are  the  dominant  phenomena  of  the  modern  world. 

§  5.  For  some  centuries  preceding  the  industrial  revolution 
of  the  eighteenth  century,  the  typical  form  of  exchange  was 
that  between  the  small  city  or  town  and  the  agricultural  region 
immediately  surrounding  it.  This  was  the  period  of  the 
simpler  form  of  the  division  of  labor,  of  the  familiar  handicraft ; 
the  period  of  the  tool,  preceding  the  modern  period  of  the 


THE  DIVISION  OF  LABOR  39 

machine.  The  city  of  early  modern  times  was  the  center  of 
an  industrial  community  which  was  in  the  main  self-contained. 
Within  the  city  the  burghers  carried  on  the  arts  and  crafts. 
To  it  the  surrounding  rural  population  brought  food  and  ma- 
terials, and  in  it  they  made  their  purchases.  The  city  crafts- 
men were  united  in  the  gilds  which  were  so  conspicuous  a 
feature  of  the  economic  organization  of  that  period.  Each 
craft  was  open  only  to  the  members  of  a  gild,  who  trained 
apprentices  and  employed  journeymen,  and  transmitted  from 
generation  to  generation  the  knowledge  of  its  trade.  The 
organization  of  the  gilds,  and  the  regulation  and  restriction 
of  their  membership,  were  inevitable  and  doubtless  beneficial 
at  the  outset,  assuring  protection  and  mutual  aid,  and  the 
maintenance  of  skill  in  the  arts.  In  later  times,  their  regula- 
tions were  made  the  means  of  monopoly;  they  had  long  out- 
lived their  usefulness  even  before  the  great  inventions  of  the 
industrial  revolution  put  an  end  to  the  economic  organization 
of  which  they  were  a  part.  But  these  are  aspects  of  the  gild 
system  not  closely  related  to  our  present  topic.  So  far  as  it 
Dears  on  the  division  of  labor,  it  was  part  of  what  the  Germans 
call  Stadtwirthschaft,  —  the  city  organization  of  industry.  A 
map  of  England  and  of  the  greater  part  of  western  Europe 
from  say  1350  to  1800  is  dotted  with  a  large  number  of  cities 
of  modest  size,  each  the  center  of  a  more  or  less  isolated  economic 
area.  There  was,  indeed,  some  exchange  of  special  commodities 
between  different  countries  and  between  the  different  economic 
areas  within  a  country;  but  the  main  exchanges  were  be- 
tween the  city  and  the  surrounding  agricultural  district,  and 
the  characteristic  stage  of  the  mechanical  arts  was  that  of  the 
division  of  labor  between  the  familiar  crafts  organized  in  the 
medieval  gilds. 

The  steps  through  which  this  organization  of  industry  has 
been  replaced  by  that  characteristic  of  modern  times  were  at 
first  slow  and  gradual.  But  in  the  eighteenth  century,  the 
industrial  revolution  brought  a  sudden  burst  of  great  changes. 
Without  pausing  to  consider  the  events  of  the  sixteenth  and 


40  THE  ORGANIZATION  OF  PRODUCTION 

seventeenth  centuries,  which  prepared  the  way  for  these  changes, 
we  may  contrast  the  final  result  with  the  conditions  of  the 
early  simpler  division  of  labor,  and  so  understand  better  the 
conditions  of  our  own  day. 

The  economic  area  has  been  immensely  widened.  It  has 
come  to  include  the  whole  of  a  country,  in  some  respects  the 
whole  of  the  world.  There  is  division  of  labor  not  only  be- 
tween the  different  crafts  within  a  city,  but  quite  as  much 
between  different  cities  and  countries.  On  the  other  hand,  the 
crafts  themselves  have  been  split  up  into  more  minute  sub- 
divisions, and  different  parts  of  each  are  followed  in  widely 
separated  localities.  These  tendencies  have  been  immensely 
promoted  by  the  modern  improvements  in  transportation,  — • 
improvements  which  have  themselves  been  the  results  of  the 
introduction  of  machinery.  The  use  of  power,  especially 
through  the  steam  engine,  was  the  dominant  factor  in  the 
industrial  revolution;  and  in  no  direction  has  it  had  larger 
effect  than  from  its  application  to  traction  and  to  navigation. 

An  epoch-making  invention  was  that  of  the  locomotive. 
Roads  had  been  much  improved  in  England  during  the  latter 
part  of  the  eighteenth  century,  when  Telford  and  Macadam 
devised  their  methods  of  constructing  roadways.  During  the 
same  period  canals  had  also  been  dug,  and  used  to  no  small 
extent  both  in  France  and  in  England;  and  the  people  of  the 
United  States,  always  driven  by  their  special  industrial  con- 
ditions to  search  eagerly  for  improvements  in  communication, 
pushed  the  use  of  roadways  and  canals  in  the  first  quarter  of 
the  nineteenth  century.  But  in  1830  came  the  locomotive. 
In  this  case,  as  in  that  of  the  steam  engine,  and  indeed  of 
almost  all  great  advances  in  the  arts,  the  final  attainment  of 
the  successful  device  was  due  to  a  long  series  of  experiments 
by  many  contrivers.  Stevenson  in  1830  perfected  rather  than 
invented  the  locomotive.  So  the  modern  railway  was  created ; 
and  thereby  began  a  second  industrial  revolution,  or  at  least 
a  second  phase  of  the  industrial  revolution.  Side  by  side 
with  the  railway  have  acted  the  great  improvements  in  water 


THE  DIVISION  OF  LABOR  41 

transportation.  The  application  of  steam  to  navigation, 
through  the  paddle  wheel,  was  a  comparatively  simple  matter, 
and  was  accomplished  early  in  the  nineteenth  century.  But 
the  paddle-wheel  steamer  was  too  clumsy,  too  liable  to  damage 
in  storm,  for  communication  across  great  bodies  of  water; 
and  it  was  not  until  Ericsson's  invention  of  the  screw,  in  the 
middle  of  the  nineteenth  century,  that  ocean  navigation  under- 
went a  great  change.  This  change  in  any  case  was  not  so  far- 
reaching  as  that  wrought  by  the  railway;  for  water  transpor- 
tation by  sailing  vessels  had  always  been  comparatively  cheap ; 
whereas  land  transportation  had  been  slow  and  dear,  and  its 
dearness  had  imposed  great  obstacles  to  the  division  of  labor 
within  large  land  areas. 

§  6.  As  Adam  Smith  remarked  in  1776,  in  the  earlier  stages  of 
the  modern  era,  the  division  of  labor  is  limited  by  the  extent 
of  the  market.  The  village  cobbler  will  turn  out  no  more 
shoes  than  it  is  possible  to  dispose  of  within  the  economic  area 
he  can  reach.  To  divide  the  work  of  shoemaking  between 
the  cutter,  the  stitcher,  the  heeler,  the  laster,  is  not  feasible 
unless  as  many  shoes  can  be  marketed  as  the  .combined  labor 
of  all  will  produce.  A  modern  shoe  factory,  with  its  elaborate 
machinery  and  highly  developed  division  of  labor,  turns  out 
thousands  of  pairs  of  shoes  daily.  These  shoes  can  find  their 
purchasers  only  in  a  large  population  reached  from  the  central 
source  of  supply. 

Many  other  illustrations  could  be  given  of  the  way  in  which 
the  divison  of  labor  has  been  pushed  farther  and  farther  with 
the  extension  of  the  market  consequent  on  cheapened  transpor- 
tation. Furniture  is  made  nowadays  in  large  factories,  often 
placed  near  the  sources  of  timber  supply  and  distant  from 
the  persons  who  are  to  use  the  articles.  The  cabinetmaker 
of  olden  days  has  been  replaced  by  workmen  who  tend  and 
direct  a  series  of  machines,  each  of  which  performs  unceasingly 
its  part  in  the  operations  of  sawing,  planing,  grooving,  turning, 
polishing.  Plows  are  no  longer  made  by  the  village  black- 
smith, but  put  together  hi  the  great  factory  and  then  distrib- 


42  THE  ORGANIZATION  OF  PRODUCTION 

uted  broadcast  over  the  earth.  Unless  it  were  possible  so  to 
distribute  them,  plows  could  not  be  made  in  quantities  at  the 
factory,  and  there  could  be  no  elaborated  division  of  labor  in 
making  them.  One  of  the  most  striking  results  of  the  widen- 
ing of  the  market  is  seen  in  the  transformation  of  the  butcher's 
trade.  Until  within  the  last  thirty  years,  the  butcher  carried 
on  his  work  as  he  had  done  it  for  thousands  of  years  before. 
His  cattle  came  from  near-by  farmers,  and  the  meat  was  sup- 
plied to  near-by  customers.  Through  the  larger  part  of  the 
United  States,  he  has  now  been  supplanted  by  the  great  pack- 
ing establishment,  where  cattle  are  slaughtered  by  the  thou- 
sand. In  these  establishments  dozens  of  different  stages  in 
dissecting  the  carcass  are  allotted  to  as  many  different  sets  of 
workmen.  The  application  of  power  has  not  here  been  carried 
as  far  as  in  some  other  industries ;  yet  at  every  stage  where  it 
is  possible,  the  machine  is  set  to  work;  and  where  it  is  not, 
the  workman  is  assigned  to  the  unceasing  repetition  of  a  single 
operation.1  Every  part  of  the  animal  is  used,  and  every  part 
is  manipulated  on  a  large  scale  under  a  further  minute  division 

1  "It  would  be  difficult  to  find  another  industry  where  division  of  labor  has 
been  so  ingeniously  and  microscopically  worked  out.  The  animal  has  been  sur- 
veyed and  laid  off  like  a  map ;  and  the  men  have  been  classified  in  over  thirty 
specialties  and  twenty  rates  of  pay,  from  16  cents  to  50  cents  an  hour.  The 
50-cent  man  is  restricted  to  using  the  knife  on  the  most  delicate  parts  of  the  hide 
(floorman)  or  to  using  the  ax  in  splitting  the  backbone  (splitter) ;  and,  wherever 
a  less  skilled  man  can  be  slipped  in  at  18  cents,  18J^  cents,  20  cents,  21  cents, 
22 J^  cents,  24  cents,  25  cents,  and  so  on,  a  place  is  made  for  him,  and  an  occupa- 
tion mapped  out.  In  working  on  the  hide  alone  there  are  nine  positions,  at 
eight  different  rates  of  pay.  A  20-cent  man  pulls  off  the  tail,  a  22J^-cent  man 
pounds  off  another  part  where  good  leather  is  not  found,  and  the  knife  of  the 
40-cent  man  cuts  a  different  texture  and  has  a  different  '  feel '  from  that  of  the 
50-cent  man.  Skill  has  become  specialized  to  fit  the  anatomy.  .  .  . 

"The  division  of  labor  grew  with  the  industry,  following  the  introduction  of 
the  refrigerator  car  and  the  marketing  of  dressed  beef,  in  the  decade  of  the  sev- 
enties. Before  the  market  was  widened  by  these  revolutionizing  inventions,  the 
killing  gangs  were  small,  since  only  the  local  demands  were  supplied.  But  when 
the  number  of  cattle  to  be  killed  each  day  increased  to  a  thousand  or  more,  an 
increasing  gang  or  crew  of  men  was  put  together ;  and  the  best  men  were  kept 
at  the  most  exacting  work."  —  Professor  J.  R.  Commons,  in  the  Quarterly 
Journal  of  Economics,  Vol.  XIX,  pp.  3,  6.  It  will  be  noticed  that  here  there  seems 
to  be  scope  for  that  advantage  from  the  division  of  labor  which  is  secured  from 
the  adaptation  of  the  tasks  to  the  varying  abilities  of  the  several  workers. 
Cp.  p.  32,  above. 


THE  DIVISION  OF  LABOR  43 

of  labor.  The  output  in  all  its  varied  forms  —  the  meat  of  all 
qualities,  the  fat,  the  hide,  the  bones,  the  horns,  the  very  hair 
—  all  is  then  marketed  to  millions  of  people,  distant  hundreds 
of  miles,  sometimes  thousands  of  miles,  from  the  packing  estab- 
lishment. All  such  elaborate  organization  and  division  rests 
on  the  possibility  of  transporting  the  products  a  great  distance, 
and  so  supplying  an  enormous  population  from  one  central 
point. 

§  7.  The  great  improvements  in  transportation  during  the 
nineteenth  century  have  given  immensely  wider  scope  to  a  phase 
of  the  division  of  labor  which  we  have  not  yet  considered. 
This  is  the  geographical  division  of  labor. 

In  medieval  and  early  modern  times,  those  articles  only 
could  be  transported  for  any  considerable  distance  which  had 
great  value  in  small  bulk.  Such  were  drugs,  spices,  fine  cloths, 
rare  silks  and  cottons,  choice  weapons  and  armor.  These 
were  used  chiefly  by  the  small  circle  of  the  rich ;  trade  in  them 
did  not  affect  the  mass  of  the  population.  Where  water  trans- 
portation could  be  used,  there  was  indeed  some  possibility  of 
trade  and  exchange  in  the  bulkier  commodities.  For  this 
reason,  England,  with  her  insular  position  and  much-indented 
seacoast,  was  able  at  a  comparatively  early  stage  to  export 
such  commodities  as  wool,  copper,  and  tin,  and  to  develop  in 
some  degree  the  geographical  division  of  labor.  With  the  im- 
provement and  enlargement  of  vessels',  the  greater  security  of 
the  seas,  and  the  use  of  the  mariner's  compass,  trade  by  water 
gradually  grew  to  greater  and  greater  dimensions.  A  still 
further  extension  came  in  the  latter  part  of  the  eighteenth 
century,  when  parts  of  the  interior  of  the  civilized  countries 
were  tapped  by  canals.  But  the  most  far-reaching  develop- 
ment of  the  geographical  division  of  labor  came  with  the  rail- 
way; for  the  railway  can  reach  all  parts  of  the  land.  The 
industry  of  almost  every  part  of  the  world  has  been  transformed 
by  this  mighty  solvent. 

The  United  States  at  the  present  time  presents  what  is  prob- 
ably the  most  extreme  case  of  geographical  division  of  labor 


44  THE  ORGANIZATION  OF  PRODUCTION 

highly  developed  under  the  influence  of  cheap  transportation. 
The  southern  part  of  New  England  is  a  manufacturing  hive. 
The  food  and  raw  materials  there  used  come  from  all  parts  of 
the  world.  The  wheat  and  other  breadstuffs  come  from  the 
Mississippi  and  Missouri  valleys;  the  meat  and  animal  prod- 
ucts from  the  same  regions,  and  some  from  regions  farther  west ; 
the  cotton  from  the  Southern  states ;  the  wool  from  the  trans- 
Missouri  region,  Australia,  Argentina,  China,  Siberia.  All 
sorts  of  manufactured  articles  are  sent  out  from  New  England 
in  exchange,  —  cotton  and  woolen  fabrics,  boots  and  shoes, 
metal  wares,  tools  and  machinery.  The  anthracite  district  of 
eastern  Pennsylvania,  again,  is4  given  wholly  to  the  mining  of 
hard  coal ;  all  its  manifold  supplies  come  from  without.  Pitts- 
burgh is  the  center  of  a  district  in  western  Pennsylvania  given 
wholly  to  the  mining  of  bituminous  coal  and  to  manufactures 
which  use  that  fuel,  such  as  iron  and  steel  and  glass.  Here 
too,  the  food,  clothing,  articles  of  comfort  and  luxury,  are 
obtained  from  all  parts  of  the  United  States  and  of  the  world. 
No  part  of  the  country  is  self-sufficing ;  each  is  constantly  send- 
ing its  products  to  distant  regions,  and  in  return  receiving  the 
product  of  distant  regions. 

An  example  no  less  striking  of  the  geographical  division  of 
labor  is  to  be  found  in  the  present  condition  of  Great  Britain. 
That  country  now  imports  the  greater  part  of  its  food,  —  four 
fifths  of  its  breadstuffs,  and  more  than  half  of  its  meat  and 
other  food  supplies.  Its  wheat  comes  chiefly  from  the  United 
States,  Canada,  Russia,  Argentina;  its  meat  very  largely 
from  the  United  States  and  Australasia.  All  the  cotton  and 
almost  all  the  wool  which  serve  to  clothe  its  people  are  brought 
from  other  countries.  These  various  commodities,  as  well  as 
the  others  which  come  from  tropical  regions,  are  obtained  in 
exchange  for  a  great  range  of  manufactures  exported.  The 
people  of  Great  Britain,  by  devoting  their  labor  chiefly  to 
manufactures  and  exchanging  them  for  the  imported  foodstuffs 
and  raw  materials,  get  vastly  larger  returns  than  they  could 
by  producing  everything  at  home.  New  England  and  old 


THE  DIVISION  OF  LABOR  45 

England  are  in  substantially  the  same  industrial  position.  It 
is  probable  that  neither  could  support  its  present  population 
on  its  own  soil;  it  is  certain  that  neither  could  satisfy  in  this 
way  the  imperative  needs  for  food,  clothing,  shelter,  warmth, 
except  on  very  much  harder  terms  and  with  very  much  scantier 
results.  Each  is  dependent  on  trade  with  other  regions;  the 
main  difference  being  that  in  the  one  case  virtually  the  whole 
of  the  trade  crosses  the  political  border,  and  in  the  other  a 
large  part  of  it  is  within  the  same  nation. 

In  consequence  of  this  highly  developed  division  of  labor, 
the  position  of  cities  is  essentially  different  from  what  it  was  in 
medieval  times.  They  are  no  longer  dependent  for  food  and 
materials  on  the  agricultural  regions  surrounding  them,  nor  do 
these  regions  depend  on  the  adjacent  cities  for  their  supplies 
of  manufactured  commodities.  As  regards  the  country  sur- 
rounding them,  the  cities  are  centers  for  the  distribution  of 
goods  rather  than  for  production.  Many  cities  have  special 
articles  of  manufacture,  and  in  this  sense  are  producing  centers ; 
but  their  specialties  are  disposed  of  over  all  the  world  through 
the  distributing  centers.  The  very  large  cities,  with  a  wide 
range  of  miscellaneous  manufactures,  and  with  a  great  dis- 
tributing trade,  overlap  in  their  economic  areas. 

§  8.  The  gains  from  the  geographical  division  of  labor  are 
of  two  sorts,  analogous  to  the  two  sorts  of  gain  from  the  divi- 
sion of  labor  between  individuals.  In  part  they  arise  from  the 
adaptation  of  different  regions  to  the  production  of  specific 
articles,  and  in  part  from  the  proficiency  which  is  the  result 
of  exclusive  application  to  one  task. 

The  division  of  labor  between  tropical  and  temperate  coun- 
tries obviously  brings  the  gain  arising  from  specific  adaptation. 
Tropical  fruits,  spices,  coffee,  sugar,  are  exchanged  for  the 
wheat  and  corn  of  temperate  climes.  The  southern  part  of  the 
United  States,  again,  has  a  climate  peculiarly  adapted  for 
growing  cotton;  while  in  the  great  central  plains  there  is  a 
corn  belt  and  a  wheat  belt,  —  great  stretches  of  country  with 
climate  and  soil  peculiarly  adapted  to  one  or  the  other  of  the 


46  THE  ORGANIZATION  OF  PRODUCTION 

staple  cereals.  The  abundant  deposits  of  excellent  coal  in  the 
western  part  of  Pennsylvania  cause  that  district  to  devote 
itself  to  coal  mining  and  to  the  industries  for  which  cheap 
fuel  is  essential.  Extraordinary  deposits  of  iron  ore  have  been 
found  on  the  shores  of  Lake  Superior,  and  thousands  of  work- 
men there  mine  the  ore,  procuring  from  other  parts  of  the  coun- 
try all  the  varied  articles  which  they  consume.  Italy  has  a 
climate  adapted  to  the  culture  of  the  grape  and  of  citrous  fruits, 
and  she  exports  them  to  the  countries  of  more  rigorous  climate. 
Italy  has  no  coal ;  she  imports  it,  chiefly  from  the  great  beds 
of  Great  Britain.  The  enumeration  might  be  indefinitely 
extended.  It  is  obvious  that  there  is  a  gain  when  the  wheat 
and  corn  are  produced  in  the  regions  favoring  them,  the  iron 
and  coal  where  they  are  most  abundant,  the  cotton  where  the 
soil  is  best.  This  geographical  division  of  labor  is  not  indeed 
all-embracing ;  there  are  obstacles  to  its  sweeping  application 
from  such  causes  as  the  force  of  custom  and  cost  of  transpor- 
tation. Yet  there  is  a  strong  and  steady  tendency  toward  the 
pursuit  of  a  branch  of  production  in  that  place  for  which  the 
natural  advantages  are  greatest. 

Different  in  origin  and  basis,  though  the  same  in  effect,  is  that 
division  of  labor  between  different  regions  which  rests  on  the 
mere  fact  of  specialization  and  acquired  skill.  Exchange  be- 
tween individuals,  though  based  in  part  on  differences  in  native 
aptitudes,  rests  in  the  main  on  acquired  dexterity.  So  it  is 
in  considerable  degree  between  different  regions.  When  once 
an  industry  is  conducted  on  a  large  scale,  with  elaborate  ma- 
chinery and  with  a  great  output,  it  will  tend  to  be  concen- 
trated. But  there  may  be  no  strong  reason  for  its  concentra- 
tion at  one  place  rather  than  another.  There  is  no  cause  in 
the  natural  conditions  why  Bridgeport  and  New  Haven  in  Con- 
necticut should  be  specialized  centers  for  the  manufacture  of 
metal  wares,  Brockton  in  Massachusetts  for  shoes,  Cohoes  in 
New  York  for  knit  goods,  Nottingham  and  Bradford  in  Eng- 
land for  laces  and  woolen  stuffs,  Lyons  for  silks,  Chemnitz  in 
Saxony  for  hosiery. 


THE  DIVISION  OF  LABOR  47 

For  certain  sorts  of  industries  there  is  simply  a  gain  when  a 
number  of  establishments  carrying  on  operations  of  the  same 
sort  are  clustered  together.  Subsidiary  industries  spring  up, 
supplying  them  with  materials  or  accessories.  When  workmen 
skilled  in  particular  operations  are  required,  their  selection  and 
adaptation  is  easier.  The  mere  attractiveness  of  a  city  (for 
most  persons)  makes  it  easier  to  secure  and  retain  a  steady  force 
of  laborers.  Sometimes  the  first  cause  of  the  location  of  an 
industry  in  a  particular  place  has  been  the  energy,  ingenuity, 
resource,  of  some  individual.  His  capacity  as  leader  builds  up 
an  establishment ;  others  then  follow  his  lead.  Sometimes  the 
natural  adaptation  of  a  spot  causes  an  industry  to  spring  up 
there,  and  later  to  persist  from  the  mere  effect  of  acquired 
advantage.  Thus  some  of  the  manufacturing  cities  of  New 
England,  such  as  Lowell  and  Lawrence,  grew  up  on  sites  having 
water  power,  before  steam  power  was  as  fully  developed  as  in 
later  times,  and  when  the  transportation  of  coal  was  more 
costly.  It  is  doubtful  whether  the  water  power  would  now 
cause  these  centers  of  population  to  be  built  up;  but  being 
there,  they  tend  to  remain.  All  through  the  broad,  flat  country 
of  the  Mississippi  Valley  there  have  sprung  up  cities  and  towns, 
of  which  one  is  the  seat  of  the  manufacture  of  vehicles,  a  second 
of  furniture,  a  third  of  engines  and  machines,  with  no  obvious 
causes  why  one  place  rather  than  another  should  possess  the 
particular  industry.  In  whatever  place  the  industry  is,  the 
advantages  of  concentration  are  secured.  A  wide  market  from 
cheap  transportation  makes  possible  the  conduct  of  the  industry 
on  a  large  scale  and  so  the  use  of  much  capital,  of  elaborate 
machinery,  of  specialization,  and  minute  division  of  labor. 

A  considerable  part  of  the  division  of  labor  between  nations, 
and  a  large  volume  of  trade  between  them,  seem  to  rest  on 
this  second  cause.  Especially  as  regards  manufactured  articles, 
some  countries  have  advantages  in  production  which  rest  not 
on  natural  resources,  but  on  acquired  efficiency.  England's 
manufacture  of  certain  kinds  of  woolen  goods,  the  silk  manu- 
facture in  France,  perhaps  the  linen  manufacture  of  the  north 


48  THE   ORGANIZATION  OF  PRODUCTION 

of  Ireland,  present  cases  of  this  kind.  This  is  the  real  basis  of 
the  argument  for  protection  to  young  industries.  So  far  as  the 
division  of  labor  between  countries  and  their  trade  are  the 
results  of  natural  differences,  they  are  best  left  to  work  out  their 
results  without  restriction.  But  so  far  as  they  rest  on  acquired 
skill,  there  is  at  least  a  possibility  that  they  may  be  superseded 
to  advantage  by  similar  division  of  labor  and  similar  trade 
within  the  country.1 

1  See  what  is  said  on  this  subject  in  Book  IV,  Chapter  37,  §  2. 


CHAPTER  4 


LARGE-SCALE  PRODUCTION 

§  1.  The  tendency  to  large-scale  production  has  shown  itself 
in  all  civilized  countries  since  the  industrial  revolution.  It 
has  profoundly  modified  social  as  well  as  economic  conditions, 
and  bids  fair  to  modify  them  still  further  in  the  future. 

The  characteristic  feature  of  the  tendency  is  that  the  size 
of  the  individual  establishment  becomes  larger,  and  that  the 
total  number  of  establishments  becomes  smaller.  In  a  period 
of  very  rapid  growth,  it  may  happen  not  only  that  each  unit 
becomes  larger,  but  that  the  total  number  increases.  More 
commonly,  however,  the  total  number  decreases,  or  remains 
stationary;  while  yet  the  individual  establishment  becomes 
greater  in  size,  and  the  productiveness  of  the  industry  as  a 
whole  is  much  enlarged.  The  following  figures  from  the  Census 
publications  of  the  United  States,  indicating  the  growth  of  some 
great  manufacturing  industries  during  the  period  from  1850  to 
1905,  will  serve  as  illustration. 

AGRICULTURAL  IMPLEMENTS 


YEAB 

No.  ESTAB- 
LISHMENTS 

WAGE- 
EARNERS 

CAPITAL 
(IN  MILLIONS) 

PRODUCT 
(IN  MILLIONS) 

1850 

1,333 

7,220 

$  3.6 

$6.8 

1860 

2,116 

17,093 

13.9 

20.8 

1870 

2,076 

25,249 

34.8 

52.1 

1880 

1,943 

39,580 

62.1 

68.6 

1890 

910 

38,827 

145.3 

81.3 

1900 

715 

46,582 

157.7 

101.2 

1905 

648 

47,394 

196.7 

112.0 

49 


50  THE  ORGANIZATION  OF  PRODUCTION 


IKON    AND    STEEL 


YEAR 

No.  ESTAB- 
LISHMENTS 

WAOE- 

EARNERS 

CAPITAL 
(IN  MILLIONS) 

PEODDCT 
(IN  MILLIONS) 

1850 

468 

24,874 

$  21.9 

$20.4 

1860 

542 

35,189 

44.6 

52.8 

1870 

808 

75,037 

121.8 

207.2 

1880 

792 

133,023 

209.9 

296.6 

1890 

719 

171,181 

414.0 

478.7 

1900 

669 

222,607 

590.5 

804.0 

1905 

605 

242,740 

948.7 

905.9 

COTTON    GOODS 


YEAR 

No.  ESTAB- 
LISHMENTS 

WAGE- 
EARNERS 

CAPITAL 

(IN  MILLIONS) 

PRODUCT 
(IN  MILLIONS) 

1850 

1,094 

92,286 

$74.5 

$  61.9 

1860 

1,091 

122,028 

98.6 

115.7 

1870 

956 

135,369 

140.7 

177.5 

1880 

1,005 

187,587 

219.5 

210.9 

1890 

905 

218,876 

354.0 

267.9 

1900 

1,055 

302,861 

467.2 

339.2 

1905 

1,154 

315,814 

613.1 

450.5 

The  figures  in  all  three  cases  tell  the  same  story.  The  total 
capital,  the  total  product,  the  total  number  of  persons  em- 
ployed, increase  at  a  very  rapid  rate.  Not  so  the  total  number 
of  establishments.  In  the  case  of  cotton  goods,  it  remains 
curiously  constant;  for  iron  and  steel,  increases  slightly;  for 
agricultural  implements,  decreases  sharply.  There  has  been 
throughout  the  half  century  a  great  and  combined  advance  in 
the  average  capital,  the  average  product,  the  average  number  of 
employees.1 

1  The  figures  are  taken  chiefly  from  Special  Reports  of  the  Census  of  1905 
(Part  IV,  Table  1,  for  Agricultural  Implements  ;  Part  IV,  p.  4,  for  Iron  ;  Special 
Report  on  Combined  Textiles,  Table  1).  For  iron,  the  figures  for  1850  and  1860, 
added  from  the  Census  Reports  for  those  years,  are  of  uncertain  value.  The 
number  of  establishments  making  cotton  goods  in  1880  is  swelled  by  the  inclu- 
sion under  that  head  of  some  outlying  establishments.  Though  subject  to  correc- 
tion for  these  reasons  and  for  others,  the  statistics  are  sufficiently  trustworthy. 

In  the  interpretation  of  the  figures,  however,  it  must  be  borne  in  mind  that 
they  do  not  tell  the  whole  story.  In  at  least  two  of  the  industries  —  iron  and 


LARGE-SCALE  PRODUCTION  51 

These  three  cases  have  been  selected  as  illustrations,  because 
they  represent  different  stages  in  the  march  of  large-scale 
production.  In  the  cotton  manufacture  the  change  during  the 
half  century  was  least.  By  1850  that  industry  was  already 
established  on  the  factory  basis,  and  since  then  no  essentially 
new  forms  of  organization  have  developed.  The  iron  manu- 
facture (that  is,  the  making  of  crude  iron  and  steel)  shows 
relatively  a  greater  change.  Most  marked  of  all  is  the  trans- 
formation in  the  third  case.  In  1850  agricultural  implements 
were  still  made  in  the  main  on  a  small  scale,  and  by  handicraft 
methods.  Since  then  large-scale  production  has  transformed 
the  industry  in  even  greater  degree  than  the  figures  indicate ; 
for  the  stated  number  of  establishments  is  swelled,  and  the 
averages  per  establishment  are  kept  down,  by  the  survival  of 
a  large  number  of  petty  shops. 

A  similar  general  tendency  shows  itself  in  all  the  advanced 
countries:  large-scale  production  gains  ground.  Yet  it  must 
not  be  supposed  that  the  growth  is  such  as  to  have  crowded 
out  the  smaller  enterprises,  or  even  to  indicate  that  in  the 
course  of  time  they  must  disappear  entirely.  Figures  enabling 
comparisons  to  be  made  for  successive  periods  and  for  all 
the  industries  of  a  given  country,  are  not  easily  found.  The 
following  are  available,  for  Germany,  and  are  significant. 
They  show  what  percentage  of  the  total  persons  employed  in 

steel,  and  agricultural  implements  —  the  average  per  establishment  is  kept  low, 
and  the  growth  of  large-scale  operations  obscured,  by  the  fact  that  a  considerable 
number  of  small  establishments  survive,  side  by  side  with  a  few  very  large  ones. 
These  few  very  large  ones  are  really  representative  of  conditions  in  the  industry ; 
but  the  census  figures  do  not  convey  this  fact.  Further,  in  all  three  industries, 
and  especially  the  iron  manufacture  and  that  of  agricultural  implements,  com- 
bination and  large-scale  operation  have  been  going  on  in  forms  of  which  the  cen- 
sus figures  do  not  take  account.  The  census  regards  an  establishment  in  any  one 
place  as  independent  and  separate,  even  though  it  be  owned  and  managed  by  per- 
sons or  corporations  having  establishments  of  the  same  sort  in  other  places.  As 
a  matter  of  fact,  during  the  last  decade  or  two,  establishments  in  different  places 
have  come  largely  under  the  control  of  the  same  corporations  or  individuals; 
hence  the  drift  toward  concentration  is  more  marked  than  the  figures  indicate. 
And,  finally,  prices  of  the  several  articles  declined  during  the  half  century  covered ; 
hence  the  increase  in  the  average  output  per  establishment  was  even  greater  in 
terms  of  quantity  (in  tons  of  iron  or  yards  of  cloth)  than  in  terms  of  value. 


52 


THE  ORGANIZATION   OF  PRODUCTION 


Germany  were  engaged,   at  certain  dates,  in  manufacturing 
establishments  of  different  size. 


1882 

1895 

1907 

Per  cent  of  persons  doing  work  alone  

25.2% 

16.4% 

10.1% 

Per  cent  of  persons  in  establishments  employ- 
ing 2  @  5  persons  

29.9 

23.5 

19.4 

Per  cent  of  persons  in  establishments  employ- 
ing 6  @  10  persons  

6.0 

7.2 

66 

Per  cent  of  persons  in  establishments  employ- 
ing 11  @  50  persons  

12.6 

16.6 

18.4 

Per  cent  of  persons  in  establishments  employ- 
ing 51  @  200  persons  

11.9 

17.0 

20.1 

Per  cent  of  persons  in  establishments  employ- 
ing 201  @  1000  persons  

10.9 

13.9 

17.3 

Per  cent  of  persons  in  establishments  employ- 
ing over  1000  persons  

3.5 

5.4 

8.1 

It  will  be  seen  that  the  one-person  establishment,  and  those 
employing  five  persons  or  less,  have  lost  ground  greatly.  Those 
in  the  next  tier  (6  to  10  employees)  hold  their  own ;  all  the  others 
gain,  and  the  very  greatest  rate  of  gain  is  in  the  class  of  very 
large  establishments.1 

§  2.  The  causes  of  the  growth  of  large-scale  production  are 
to  be  found  mainly  in  the  revolutionary  changes  in  the  arts 
during  the  last  century  and  a  half.  Underlying  them  all  is  the 
increasing  division  of  labor  and  the  increasing  use  of  machinery. 
A  necessary  condition  has  been  the  widening  of  the  market 
under  the  influence  of  the  opened  transportation. 

A  tool  or  machine  of  any  kind  is  advantageous  only  if  it  is 
used  for  a  number  of  operations.  The  greater  the  number  of 
operations,  the  more  is  it  worth  while  to  have  an  elaborate  tool, 
and  to  give  much  labor  to  its  making.  Machinery  moved  by 

1 1  take  these  figures  from  Professor  Bucher's  paper  in  the  Zeitschrift  ftir  die 
gesammte  Staalswissenschaft,  1910,  Heft  3,  p.  430.  Professor  Biicher  points  out 
that  for  Germany,  as  for  the  United  States,  census  figures  do  not  tell  the  whole 
story  of  the  growth  of  large-scale  operations,  since  several  establishments  forming 
part  of  one  larger  enterprise  are  frequently  reckoned  by  the  censua  as  separata 
and  independent. 


LARGE-SCALE  PRODUCTION  53 

power  is  a  highly  elaborate  tool.  The  larger  the  scale  on  which 
an  enterprise  is  conducted,  the  better  is  the  opportunity  for 
using  machinery  to  advantage.  The  gain  from  its  use  arises 
from  several  sources.  Power  itself  becomes  cheaper  per  unit 
as  it  is  applied  on  a  large  scale.  Both  for  first  installment  and 
for  running  expenses,  a  large  steam  engine  costs  less,  for  each 
horse  power,  than  a  small  one ;  which  means  economy  if  the 
establishment  is  large  enough  to  utilize  all  the  power  supplied. 
Again,  subsidiary  operations  can  be  carried  on  to  advantage 
by  machinery.  The  use  of  steam  shovels  in  handling  coal,  ores, 
earth,  and  of  similar  instruments  for  loading  and  unloading 
vessels,  depends  on  the  work  being  massed  in  large  quantities 
at  one  spot.  An  ocean  steamship  of  10,000  tons  carries  freight 
more  cheaply  than  one  of  5000,  and  one  of  20,000  tons  more 
cheaply  still.  Wherever  the  traffic  is  heavy,  as  between  Europe 
and  the  United  States,  the  huge  steamship  is  economical. 
Where  the  traffic  is  less  heavy  and  less  regular,  as  in  the  trade 
with  South  America  and  outlying  regions,  the  ship  of  moderate 
size  holds  its  own.  The  greatest  of  the  American  corporations 
making  agricultural  implements,  one  that  illustrates  conspicu- 
ously the  tendency  to  large-scale  production,  —  the  Inter- 
national Harvester  Company,  —  has  a  machine  whose  sole  work 
is  to  shape  poles  for  wagons  and  harvesters.  The  machine 
cost  $2500;  it  saves  a  cent  per  pole;  it  is  worth  while  only 
because  poles  by  the  hundred  thousand  are  made  each  year. 

Other  causes,  more  or  less  closely  connected  with  the  growing 
use  of  machinery,  have  strengthened  the  tendency  to  large- 
scale  production.  Just  as  all  the  several  expenses  for  the  plant 
and  power  become  less  per  unit  as  the  output  enlarges,  so  the 
general  expenses  for  administration  and  counting-room  work 
tend  to  become  less.  Clerks  are  kept  more  continuously  oc- 
cupied, and  more  elaborate  division  of  labor  among  them  is 
feasible.  Superintendent  and  foreman  can  take  charge  of  the 
full  number  of  men  which  each  can  direct  to  advantage.  One 
watchman,  one  engineer,  one  timekeeper,  can  usually  serve  a 
large  establishment  as  effectively  as  a  small  one.  All  the  mis- 


54  THE   ORGANIZATION  OF  PRODUCTION 

cellaneous  expenses  of  general  management  are  less  in  proportion 
to  a  large  output. 

The  mercantile  management  of  a  large  enterprise  —  the  buy- 
ing of  materials  and  the  selling  of  the  product  —  also  offers 
opportunity  for  economy  and  efficiency.  Supplies  can  usually 
be  bought  to  greater  advantage.  This  is  commonly  spoken  of 
as  if  due  simply  to  greater  bargaining  power  on  the  part  of  the 
large  buyer,  and  to  greater  pressure  of  competition  among  those 
who  wish  to  sell  to  him.  But  in  the  main  it  is  due  to  the  fact 
that  mercantile  operations  themselves,  and  especially  whole- 
sale operations,  are  carried  on  more  economically  when  on  a 
large  scale.  Expenses  for  clerk  work,  rentals  of  office  premises, 
and  the  like,  which  constitute  the  main  outlays  of  the  wholesale 
dealer,  are  no  greater  for  large  transactions  than  for  small. 
Hence  brokers  and  wholesale  dealers  can  sell  at  lower  prices  to 
those  who  buy  habitually  in  large  amounts. 

Again,  the  disposal  of  the  output  is  often  at  less  expense  for 
a  large  establishment  than  for  a  small  one,  and  often  at  still  less 
expense  for  a  very  large  establishment  than  for  a  moderately 
large  one.  Advertising  and  notoriety  much  affect  the  marketing 
of  sundry  commodities.  When  once  appeal  is  made  not  to  a 
limited  local  market  but  to  a  large  and  extensive  constituency, 
the  disposal  of  the  great  quantities  of  goods  turned  out  by  a 
modern  factory  becomes  by  no  means  the  least  difficult  of  its 
manager's  tasks.  All  the  apparatus  for  drumming  up  custom  — 
traveling  salesmen,  trade  catalogues,  and  the  like  —  is  the  more 
effective,  and  the  less  costly  per  unit  of  product,  in  proportion  as 
it  operates  on  a  large  scale.  Advertising  is  most  effective  when 
spread  over  the  land  with  every  sort  of  device ;  when  it  is  sys- 
tematized and  put  in  charge  of  a  separate  manager.  All  such 
elaboration  of  marketing  is  both  a  result  and  a  further  cause  of 
a  great  volume  of  business. 

The  utilization  of  "by-products"1  is  another  of  the  advantages 
of  large-scale  production.  At  the  great  packing  houses  which 

1  Better,  "joint  products"  ;  see  Book  II,  Chapter  16,  §  1. 


LARGE-SCALE  PRODUCTION  55 

do  so  much  of  the  butcher's  work  of  the  United  States,  every 
particle  of  the  slaughtered  animal  is  used,  and  many  things 
which  would  go  to  waste  in  the  small  shop  become  a  source 
of  profit.  A  very  large  woolen  factory  finds  it  advantageous 
to  utilize  the  fatty  matter  which  is  attached  to  the  wool  as  it 
comes  from  the  sheep's  back.  This  grease,  which  must  in  any 
case  be  scoured  out  of  the  wool,  goes  to  waste  in  a  smaller  es- 
tablishment ;  whereas  the  large  mill,  by  putting  in  a  plant  for 
the  special  purpose  of  treating  the  grease,  finds  it  a  source  of 
gain.  Great  ironworks  find  it  possible  to  utilize  the  gas  expelled 
from  coal  in  the  coking  process ;  either  selling  the  gas,  purified,  in 
a  near-by  city,  or  using  it  at  once  for  fuel  in  their  own  fur- 
naces. A  large  sawmill  can  put  in  a  plant  for  burning  its  own 
sawdust,  dispensing  with  other  fuel  for  power. 

Other  advantages  of  large-scale  production  arise  from  the 
possibilities  of  experimenting  with  new  devices  and  new  meth- 
ods. Some  ventures  will  fail,  some  succeed.  In  a  very  great 
enterprise,  the  successes  may  be  expected  in  the  long  run  to 
outweigh  the  failures;  the  enterprise  insures  itself,  so  to  speak, 
against  the  inevitable  risks  of  experimenting.  Where  opera- 
tions are  conducted  on  a  small  scale,  the  failure  of  one  experi- 
ment may  ruin  the  entire  undertaking.  Again,  the  best  tech- 
nical skill,  the  best-trained  engineers  and  chemists,  are  more 
easily  and  more  economically  employed  by  the  great  establish- 
ment. As  with  expensive  but  efficient  machinery,  their  use  is 
advantageous  only  for  a  very  large  output,  and  is  most  eco- 
nomical for  the  largest  output. 

§  3.  The  limitations  on  large-scale  production  arise  mainly 
from  the  infirmities  of  human  nature.  The  extension  of  the 
scale  of  operations  means  an  ever  increasing  reliance  upon  hired 
labor  and  an  ever-lessening  reliance  on  spontaneous  self-interest. 
If  all  men  worked  with  as  much  energy  and  spirit  for  an  em- 
ployer as  they  do  for  themselves,  the  spread  of  large-scale 
production  would  be  almost  without  bounds.  A  striking  illus- 
tration of  the  influence  of  this  limiting  factor  is  shown  in  the 
differing  tendencies  of  agriculture  and  of  manufactures. 


56  THE  ORGANIZATION  OF  PRODUCTION 

The  operations  of  agriculture  are  necessarily  spread  over  a 
considerable  area;  and  they  are  not  easily  subjected  to  a  fixed 
routine.  Both  circumstances  make  supervision  difficult.  Man- 
ufactures, on  the  other  hand,  bring  the  concentration  of  hundreds 
or  thousands  of  workmen  under  a  single  roof  or  in  a  small  area. 
Moreover,  in  manufactures,  machinery  means  the  repetition  of 
identical  operations.  Hence  a  routine  can  be  fixed,  and  work- 
men assigned  to  fixed  tasks,  and  their  faithfulness  controlled, 
with  comparative  ease.  But  in  agriculture  much  must  be  left 
to  the  zeal  and  intelligence  of  the  individual  worker. 

The  consequence  is  that  agriculture  has  nowhere  shown  the 
same  tendency  to  enlargement  of  the  scale  of  production  which 
is  so  unmistakable  in  manufactures.  It  is  true  that  some 
countries  are  usually  spoken  of  as  countries  of  large  farming; 
England  is  the  type  of  such  a  country.  It  is  true,  also,  that  in 
some  parts  of  the  United  States  (in  the  North  Central  region, 
for  example)  there  has  been  in  recent  years  a  slight  tendency  to 
increase  in  the  size  of  farms.  But  a  farm  which  is  called  large 
is  an  industrial  unit  of  comparatively  small  size.  One  which 
employs  twenty  men  the  year  round  is  considered  large;  yet 
a  factory  employing  this  number  is  a  small  affair.  The  tasks 
of  twenty  men  engaged  in  farming  would  be  spread  over  several 
hundred  acres,  and  must  present  troublesome  questions  in  as- 
signing and  supervising  the  work.  Farms  of  this  size  are  com- 
paratively rare.  By  far  the  greater  part  of  agricultural  work 
is  done  on  farms  where  a  single  man,  having  under  him  perhaps 
one  other  or  a  few  others,  conducts  the  operations  on  his  own 
account.  In  the  early  stages  of  the  development  of  some  parts 
of  the  United  States,  so-called  "bonanza"  farming  has  appeared 
for  a  time.  Where  great  level  tracts  of  fertile  land  have  been 
suddenly  opened  to  cultivation,  as  in  the  interior  valleys  of 
California  or  in  the  Red  River  Valley  of  the  Dakotas,  wheat 
culture  has  sometimes  been  carried  on  for  a  while  over  thousands 
of  acres,  with  dozens  of  men  and  vehicles  and  with  expensive 
machinery.  But  this  has  proved  only  a  temporary  phase.  As  the 
fertility  of  virgin  soil  begins  to  be  exhausted,  and  a  more  varied 


LARGE-SCALE  PRODUCTION  57 

and  careful  use  of  it  is  called  for,1  these  great  tracts  are  split  up 
into  smaller  units.  The  head  of  a  large  factory  can  devise  means 
for  supervising  his  men  and  for  securing  the  execution  of  his 
orders.  But  the  owner  of  a  farm  can  use  hired  labor  to  advan- 
tage only  when  his  own  example  and  his  own  oversight  supply 
the  needed  stimulus. 

Some  industries,  though  spread  over  a  large  area  and  presenting 
difficulties  for  the  supervision  of  hired  labor,  are  so  much  more 
effective  when  on  a  large  scale  that  these  disadvantages  are  not 
decisive.  The  railway  is  an  example.  Many  of  its  employees 
are  necessarily  scattered  over  great  tracts  of  country.  The 
supervision  of  the  innumerable  agents  calls  for  an  intricate  and 
expensive  apparatus  of  rules  and  regulations,  bookkeeping  and 
auditing.  But  the  work  is  done  so  much  more  cheaply  on  a 
large  scale  that  this  difficulty  and  the  expense  entailed  by  it 
are  more  than  offset. 

Sometimes,  on  the  other  hand,  industries  which  offer  possi- 
bilities of  economy  from  large  operations  are  for  other  reasons 
limited  to  small  ones.  Though  retail  dealings  can  be  conducted 
to  advantage  on  a  large  scale,  —  with  economies  in  purchases  and 
in  administration,  with  better  utilization  of  premises,  with  more 
continuous  activity  by  the  force  of  salesmen,  —  the  smaller  shops 
still  hold  their  own.  The  opportunities  for  large-scale  retailing 
are  availed  of  in  the  cities  by  the  so-called  department  stores ; 
establishments  whose  growth  has  been  immensely  promoted  of 
late  years  by  the  improvements  in  urban  transportation.  But 
even  in  a  large  city,  and  especially  in  its  outlying  quarters,  small 
or  moderate  retail  shops  continue.  The  reason  is  that  often  the 
purchaser  must  have  his  source  of  supply  near  at  hand.  The 
ubiquitous  corner  drug  store  of  our  American  cities  persists 
against  large  competitors. 

A  glance  at  such  a  volume  as  the  Statistical  Abstract  of  the 
United  States,  with  its  summary  of  the  number  of  establish- 
ments and  volume  of  transactions  hi  various  kinds  of  business, 
shows  instructively  which  among  them,  for  reasons  of  this  sort, 

i  Compare  Book  V,  Chapter  42,  §  5. 


58  THE  ORGANIZATION  OF  PRODUCTION 

lesist  the  tendency  to  concentration.  The  strictly  manufacture 
ing  establishments  show  the  characteristic  features  of  the  mod- 
ern movement.  Though  the  volume  of  transactions  becomes 
immensely  greater,  the  number  of  establishments  becomes  less. 
So  it  is  with  the  manufacture  of  agricultural  implements,  of 
boots  and  shoes,  of  carpets,  chemicals,  firearms,  glass,  cotton, 
woolen  and  silk  fabrics,  sewing  machines.  Those  industries 
which,  like  the  retail  shop,  purvey  more  directly  to  the  consumer, 
or  for  other  reasons  must  be  near  the  persons  with  whom  they 
have  dealings,  increase  their  numbers  pari  passu  with  the  increase 
in  population  and  with  the  volume  of  their  own  transactions. 
Such  are  blacksmithing,  carpentering,  plumbing,  bread  baking, 
printing,  painting,  and  paper  hanging.  Here  there  is  no  marked 
tendency  toward  an  enlargement  of  the  size  of  the  individual 
establishment,  still  less  any  victory  of  great-scale  production. 

The  limitations  of  men's  faculties  explain  why  large-scale 
operations  do  not  make  their  way,  even  in  manufactures,  with 
unfailing  certainty.  What  has  been  said  in  the  preceding  para- 
graphs may  seem  to  imply  that  the  transition  to  greater  size 
takes  place  quasi-automatically.  This  is  by  no  means  the  case. 
It  depends  on  the  energy,  ambition,  insight,  of  individual  men. 
Every  new  machine,  every  change  to  larger  scale,  involves  risks, 
calls  for  planning  and  judgment,  is  dependent  on  some  individ- 
ual's initiative.  If  an  indefinite  number  of  individuals  were 
capable  of  this  sort  of  work,  the  march  of  progress  would  be  faster 
and  large-scale  operations  would  make  their  way  more  surely 
and  speedily.  As  it  is,  these  changes  wait  on  the  impulse  given 
by  the  comparatively  few  individuals  who  have  the  capacity 
for  industrial  leadership.  Occasionally  some  such  individual 
reorganizes  his  business  upon  a  larger  scale  and  with  more 
highly  developed  plant  and  machinery.  Then  others  follow 
his  lead,  and  a  whole  industry  is  rapidly  transformed.  This 
has  happened  during  the  last  two  decades  in  the  iron  manufac- 
ture, especially  in  the  United  States  and  in  Germany.  Carnegie 
in  the  former,  Krupp  in  the  latter,  led  the  way  in  a  remarkable 
development.  Usually,  however,  the  advance  takes  place  by 


LARGE-SCALE  PRODUCTION  59 

gradual  and  tentative  steps,  like  those  in  the  growth  of  the  size 
of  ocean  steamships.  The  industrial  revolution,  so  far  as  regards 
its  pace,  has  been  in  reality  not  a  revolution  but  a  slow  and 
gradual  change,  dependent  on  the  energy  and  ingenuity  of  in- 
dividuals, and  limited  by  the  scarcity  of  men  possessing  such 
qualities. 

§  4.  A  new  phase  of  large-scale  production  has  come  to  be  of 
great  and  almost  ominous  importance  during  the  present  gen- 
eration. Perhaps  it  should  be  called  large-scale  management 
rather  than  large-scale  production;  since  it  involves  not  so 
much  an  increase  in  the  size  of  the  individual  establishments  as 
the  combination  under  single  management  of  several  estab- 
lishments. It  takes  two  forms,  which  may  be  described  as 
horizontal  and  vertical. 

Horizontal  combination  is  the  union  under  single  management 
of  a  number  of  enterprises  of  the  same  sort.  They  are  usually 
few,  and  each  is  usually  on  a  large  scale.  As  the  size  of  the 
representative  establishment  in  any  industry  enlarges,  and  the 
number  of  individual  establishments  shrinks,  the  stage  is  finally 
reached  where  but  a  few  survive  —  a  dozen,  perhaps.  These 
then  combine;  not  in  the  sense  that  one  huge  establishment 
supersedes  the  dozen,  but  that  the  dozen,  while  retaining  their 
technical  independence,  are  owned  and  managed  as  one.  Though 
large-scale  operation  may  have  reached  its  limit  so  far  as  the 
mechanical  apparatus  of  production  goes,  some  gain  may  still 
be  secured  from  united  large-scale  administration.  A  typical 
example  is  the  American  Sugar  Refining  Company.  A  modern 
refinery  is  a  huge  concern,  costing  a  couple  of  millions  of  dollars, 
and  putting  out  10,000,  even  15,000,  barrels  of  sugar  a  day.  Yet 
there  are  limits  to  its  size.  Beyond  a  certain  point,  enlargement 
no  longer  adds  economy  in  operation.  When  an  output  be- 
yond this  capacity  is  called  for,  a  second  refinery  of  the  same 
kind  is  erected,  and  so  on  until  the  total  supply  is  provided. 
All  these  refineries,  however,  may  be  managed  from  one  com 
mon  center,  with  at  least  possibilities  of  economy.  Their  sup- 
plies may  be  bought  in  common,  and  distributed  among  them 


60  THE  ORGANIZATION  OF  PRODUCTION 

in  such  a  manner  as  to  insure  continuity  in  operation  and  the 
minimum  outlay  for  transportation.  This  last  factor,  economy 
in  transportation,  is  of  great  consequence  where  the  chief 
material  (raw  sugar,  in  this  instance)  comes  from  great  distances, 
and,  being  rapidly  worked  up,  must  be  continually  and  sys- 
tematically replaced.  Machinery  may  be  made  identical,  or 
"standardized,"  in  the  different  works,  and  its  repair  and  re- 
placement thus  facilitated.  These  and  other  possible  economies 
may  be  offset,  to  be  sure,  in  whole  or  in  part,  by  the  inherent  diffi- 
culties of  large-scale  management,  —  notably  the  increasing 
difficulty  of  supervision.  Experience,  and  especially  the  test 
of  competition,  can  alone  settle  with  certainty  whether  the 
advantages  offset  the  disadvantages. 

Horizontal  combination  is  typical  of  the  so-called  "trust." 
The  motive  for  such  union  under  single  management  is  two- 
fold. Partly  it  is  to  secure  economy  in  management;  but 
largely  it  is  to  put  an  end  to  competition  and  bring  about  a 
more  or  less  effective  monopoly.  So  far  as  economy  is  secured, 
the  movement,  which  has  attained  such  extraordinary  dimen- 
sions in  the  last  ten  years,  may  be  to  the  public  advantage. 
But  if  monopoly  develops,  it  has  grave  possibilities  of  public 
disadvantage.  How  far  monopoly  in  fact  is  likely  to  result, 
and  how  far  cheapening  of  production  is  in  fact  brought  about, 
is  still  uncertain;  time  and  experience  alone  can  show.  But 
it  is  clear  that  in  some  respects  at  least,  and  for  some  indus- 
tries, such  combination  brings  an  extension  of  large-scale  pro- 
duction and  concentrated  management. 

Different  in  its  essential  features  is  vertical  combination,  or, 
as  it  is  sometimes  called,  the  integration  of  industry.  The 
usual  outcome  of  the  division  of  labor  has  been  that  the  several 
steps  in  production  which  succeed  each  other  in  time  have 
been  conducted  in  independent  establishments.  But  in  some 
important  trades  there  has  appeared  of  late  a  tendency  to  unite 
such  successive  stages  under  single  management.  Thus  the 
iron  industry,  in  the  traditional  organization,  was  split  up  into  a 
number  of  separate  branches.  One  producer  —  that  is,  a 


LARGE-SCALE  PRODUCTION  61 

capitalist  hiring  and  directing  a  group  of  workmen  —  carried 
on  ore  mining,  and  disposed  of  his  ore  to  other  producers  en- 
gaged in  smelting  it  into  pig  iron.  Still  another  producer 
similarly  cut  the  wood  and  converted  it  into  charcoal,  —  this 
in  earlier  days  when  wood  supplied  the  fuel  for  iron  making; 
or,  after  coke  supplanted  charcoal,  mined  the  coal  and  made 
it  into  coke.  The  pig-iron  maker,  who  had  bought  the  ore 
and  the  fuel,  sold  his  product  to  the  puddler  or  steel  maker, 
who  in  turn  sold  his  bar  iron  or  steel  to  the  machinist,  the 
builder,  the  wire  maker.  Vertical  combination,  or  the  inte- 
gration of  industry,  appears  when  all  these  successive  steps  are 
united  under  single  management,  — •  when  all  the  phases  of  iron 
and  steel  making  are  combined  in  one  great  enterprise. 

The  United  States  Steel  Corporation  carries  out  this  sort  of 
combination  in  a  typical  manner,  and  on  an  enormous  scale. 
Itself  a  union  of  previous  combinations  which  had  adopted 
the  same  method  on  a  scale  already  great,  this  corporation 
owns  vast  mines  of  iron  ore,  of  coal,  and  of  limestone.  The 
mines  are  situated  chiefly  on  the  shores  of  Lake  Superior,  the 
coal  mines  chiefly  in  Pennsylvania.  Most  of  the  ore  is  carried 
to  the  coal,  and  smelted  in  the  great  iron-making  district  of 
which  Pittsburgh  is  the  center ;  but  in  part  the  coal  is  carried 
north  and  west,  meeting  the  ore  halfway,  to  be  smelted  at 
various  places  on  the  Great  Lakes.  To  transport  these  ma- 
terials, the  corporation  has  its  own  railways  in  the  Lake  Su- 
perior region,  and  in  the  region  from  Pittsburgh  to  Lake  Erie; 
and  it  owns  a  great  fleet  of  steamers  and  barges  on  the  Lakes. 
The  pig  iron,  made  in  its  own  furnaces,  is  converted  into  steel 
of  various  shapes  in  its  own  steel  mills.  The  further  operations 
of  converting  the  steel  into  rails,  structural  and  bridge  shapes, 
plates  and  sheets,  tubing,  and  wire,  are  carried  on  in  still  other 
establishments.  In  no  other  industry,  and  nowhere  else  in  the 
world,  has  the  experiment  of  vertical  combination  been  con- 
ducted on  so  great  a  scale. 

The  iron  and  steel  manufacture  offers  an  unusually  tempting 
field  for  vertical  combination,  chiefly,  it  would  seem,  because 


62  THE  ORGANIZATION  OF  PRODUCTION 

of  the  concentration  of  the  supplies  of  raw  material,  —  coal 
and  iron  ore.  Those  who,  at  any  stage  of  rising  demand, 
possess  the  mines  of  coal  and  iron,  have  the  whip  hand  in  the 
situation ;  hence  the  manufacturers  of  the  more  finished  forms 
of  iron  and  steel  have  sought  to  gain  control  of  the  mines,  by 
purchase  or  amalgamation.  This  tendency  has  shown  itself  in 
some  degree  in  Great  Britain,  and  has  proceeded  in  Germany 
almost  as  far  as  in  the  United  States.  The  combination  of  a 
series  of  superimposed  establishments  has  now  become  the 
normal  form  of  organization  in  the  iron  manufacture. 

Some  tendencies  of  the  same  sort  are  found  in  other  indus- 
tries. The  International  Paper  Company  owns  great  tracts  of 
spruce  forest,  cuts  the  timber  and  logs,  floats  them  to  its  own 
pulp  mills,  and  there  manufactures  the  paper  which  is  used  in 
such  enormous  quantity  by  our  newspapers.  The  Harvester 
Company,  already  referred  to,  owns  forests  and  cuts  timber; 
it  owns  its  iron  and  coal  mines,  and  makes  its  iron  and  steel. 
The  Sugar  Refining  Company  owns  its  forests  and  makes  its 
barrels.  Other  industries  have  shown  a  similar  development 
in  another  direction,  —  in  the  marketing  of  goods.  The  usual 
arrangement  is  for  a  separation  between  manufacturing  and 
marketing.  The  shoe  manufacturer  commonly  sells  his  output 
to  the  wholesale  dealer  or  "selling  agent,"  who  in  turn  often 
sells  to  an  intermediate  dealer,  the  jobber,  and  sometimes 
directly  to  the  retailer.  But  some  shoe  manufacturers  have 
undertaken  not  only  the  making  but  the  marketing  of  their 
wares.  They  have  established  their  own  retail  shops,  scattered 
in  many  cities  over  the  country,  and  through  them  deal  directly 
with  the  consumer.  Again,  the  American  Tobacco  Company, 
by  establishing  its  own  retail  shops  in  great  numbers,  has  like- 
wise combined  the  distribution  of  goods  with  their  production. 

Vertical  combination  and  horizontal  combination  may  go 
hand  in  hand.  The  American  Tobacco  Company  has  attempted 
to  combine  all  the  establishments  manufacturing  tobacco  for 
smoking  and  chewing ;  and  the  extension  of  its  operations  into 
the  retail  disposal  of  its  products  has  been  the  outgrowth  of 


LARGE-SCALE  PRODUCTION  63 

the  endeavor  to  form  and  strengthen  this  all-embracing  hori- 
zontal combination.  The  Steel  Corporation  owns  many  iron 
furnaces,  many  steel  mills,  many  tube  works,  many  sheet-steel 
and  tin-plate  works,  and  thus  exemplifies  also  the  union  of  the 
two  kinds  of  combination.  The  Steel  Corporation  has  carried 
horizontal  combination  in  some  branches  to  the  point  of  nearly 
complete  monopoly;  thus  it  owns  virtually  all  the  sheet-steel 
and  tin-plate  mills  and  tube  works  in  the  United  States.  But 
it  produces  little  more  than  half  the  pig  iron,  and  has  by  no 
means  a  monopoly  of  the  steel  rails  or  structural  steel.  In 
Germany,  the  Stahlwerksverband  (Steel  Works  Association)  has 
formed  a  compact  pool  in  the  iron  and  steel  manufacture, 
though  one  that  does  not  go  the  full  length  of  completely  unified 
ownership.  In  Great  Britain,  on  the  other  hand,  while  many 
large  works  have  extended  their  operations  downward  to  the 
control  of  mines  and  upward  to  the  making  of  finished  products, 
there  is  very  little  of  horizontal  combination;  the  several  great 
enterprises  go  their  own  way  independently.  In  the  case  of 
the  boot  and  shoe  manufacturers,  just  spoken  of,  who  own 
their  own  tanneries  or  sell  at  retail  their  own  shoes,  the  com- 
bination is  vertical  only;  there  is  no  attempt  at  horizontal 
combination. 

The  movement  toward  vertical  combination  is  less  strong 
than  that  toward  horizontal  combination.  The  iron  trade, 
which  presents  so  striking  a  case  of  the  former,  is  exceptional. 
The  desire  to  secure  control  of  a  limited,  or  at  least  concen- 
trated, raw  material,  which  has  promoted  the  integration  of 
the  iron  trade,  has  not  affected  others,  in  which  the  sources  of 
raw  material  are  more  scattered.  In  the  manufacture  of 
cotton,  wool,  silk,  or  flax,  there  is  no  indication  of  any  move- 
ment for  control  of  the  supply  of  raw  material  or  for  vertical 
combination  in  any  other  way.  On  the  contrary,  the  tendency 
seems  to  be  rather  toward  a  minuter  division.  The  textile 
industries  in  Great  Britain  and  on  the  "Continent  have  always 
been  split  up  into  separate  industries  to  a  greater  degree  than  in 
the  United  States.  In  Europe,  spinning,  weaving,  bleaching, 


64  THE  ORGANIZATION  OF  PRODUCTION 

dyeing,  printing,  are  usually  carried  on  as  distinct  industries. 
The  tradition  in  the  United  States  has  been  for  the  combina- 
tion of  several  of  these  steps  —  especially  spinning  and  weav- 
ing —  in  one  organization ;  yet  even  in  this  country  the  move- 
ment of  late  years  seems  to  be  in  the  other  direction.  In 
the  shoe  manufacture,  while  there  has  been  the  marketing 
arrangement  just  noted,  and  in  some  cases  a  combination  of 
leather  tanning  with  manufacturing,  the  trend  does  not  seem 
to  be  toward  greater  combination.  Some  establishments  do 
nothing  but  make  soles,  others  do  nothing  but  make  box  toes, 
and  so  on. 

The  movement  toward  combination,  whether  horizontal  or 
vertical,  is  in  part  a  result  of  the  intensified  competition  which 
comes  with  the  greater  investment  of  fixed  capital  and  the 
greater  size  of  the  separate  enterprises.  But  very  largely  it 
results  from  the  discovery  of  the  possibilities  of  organization. 
What  are  the  limits  to  the  size  of  the  enterprise  which  can  be 
managed  as  a  unit?  The  single  factory,  perhaps  large,  was 
supposed  until  comparatively  recent  times  to  represent  that 
limit.  But  as  the  scale  of  industry  has  been  enlarged,  the 
operations  have  been  systematized  and  subjected  to  more 
perfect  control.  The  task  of  management  itself  has  been  sub- 
divided. Separate  persons  are  intrusted  with  the  purchase  of 
supplies,  the  sale  of  product,  the  maintenance  of  plant,  the 
hiring  and  superintendence  of  labor,  accounting  and  auditing. 
The  genius  of  men  with  great  inborn  capacity  for  business 
has  led  to  even  greater  perfection  of  organization.  The  tele- 
graph, the  telephone,  improved  postal  service,  have  promoted 
large-scale  management  as  they  have  large-scale  production. 
These  striking  changes  have  been  the  results  of  skill,  judgment, 
and  administrative  capacity  in  the  guiding  individuals,  and  also 
the  cause  of  an  increasing  demand  for  the  persons  possessing 
such  qualities. 

None  the  less,  the  larger  the  scale  of  operations,  the  more 
do  its  disadvantages  appear.  There  is  need  for  an  expensive 
system  of  control,  —  for  supervision,  accounting,  auditing,  the 


LARGE-SCALE   PRODUCTION  65 

effective  prompting  of  energy  and  economy.  The  test  of  com- 
petition settles  in  the  long  run  whether  the  great  combination 
is  the  more  efficient  agent  in  production.  If  it  can  produce 
more  cheaply,  it  can  sell  more  cheaply,  and  displace  its  rivals.1 

§  5.  Notwithstanding  the  wastes  of  competition,  and  the 
possible  economies  of  large-scale  production,  competing  estab- 
lishments hold  their  own  over  the  greater  part  of  the  field  of 
industry.  There  is  no  present  prospect  that  competition  will 
be  generally  supplanted  by  combination  and  monopoly. 

That  competition  operates  wastefully  seems  in  some  cases 
obvious.  The  milk  of  a  city,  for  example,  is  usually  supplied 
by  a  number  of  dealers,  each  with  his  own  set  of  customers 
scattered  irregularly  over  a  large  area.  If  all  who  lived  in  a 
given  quarter  were  supplied  by  one  dealer,  a  clear  economy  in 
delivery  would  be  secured.  If  the  whole  supply  for  an  entire 
urban  district  were  under  single  large-scale  management,  there 
would  be  a  possibility  of  cheapening  the  product  still  further, 
and  (what  in  this  case  is  specially  important)  of  improving  its 
quality.  Retail  dealers,  especially  in  such  things  as  groceries 
and  foodstuffs,  overlap  in  similar  wasteful  fashion.  Commonly, 
too,  the  areas  supplied  by  competing  manufacturers  overlap. 
Advertising,  again,  seems  to  be  in  large  part  designed  to  induce 
a  customer  to  turn  simply  from  one  dealer  to  another.  If 
there  were  no  competition,  —  if  one  great  establishment  sup- 
planted ten  rivals,  —  the  same  wants  would  make  themselves 
felt,  the  same  purchases  would  be  made,  the  expense  of  adver- 
tising eliminated,  the  goods  sold  cheaper. 

Though  some  tendency  is  seen  toward  getting  rid  of  the  causes 
of  waste,  the  tendency  is  not  very  marked.  With  the  growth 
of  great  cities,  large  firms  and  companies  have  come  in  great 
degree  to  control  urban  milk  supply,  yet  with  little  indication 
that  complete  and  systematic  combination  is  emerging.  The 
great  manufacturing  "trusts"  endeavor  to  avoid  cross  freights, 
by  making  shipments  from  that  one  among  their  establishments 

1  To  this  statement  of  the  automatic  action  of  competition  there  are  some 
qualifications,  considered  in  Book  VII,  Chapter  63,  §  3. 


66  THE  ORGANIZATION  OF  PRODUCTION 

which  is  nearest  the  point  of  delivery.  But,  as  a  rule,  rnanu* 
facturers  continue  to  compete  and  to  ship  in  a  seemingly  hap- 
hazard way.  The  same  is  true  of  retail  trade,  where  all  sorts 
of  establishments,  great  and  small,  vie  for  the  customer  and 
duplicate  facilities  in  the  traditional  and  apparently  wasteful 
fashion. 

The  waste  is  probably  less  than  it  seems.  Competition  keeps 
every  one  keyed  to  a  high  pitch,  nerves  the  shrewd  and  alert, 
weeds  out  the  inefficient.  Advertising  is  part  of  the  mechan- 
ism of  competition  as  well  as  of  combination.  Not  least,  com' 
petition  leaves  the  purchaser  some  freedom;  he  is  not  sub- 
jected to  the  alternative  of  turning  to  one  single  purveyor  or 
else  doing  without.  Even  the  most  benevolent  and  considerate 
monopolist  becomes  often  exasperating;  how  much  more  so 
the  ordinary  trader  when  no  longer  spurred  by  competition  ! 
A  choice  as  to  what  you  would  have,  and  when  and  how  you 
would  have  it,  satisfies  a  deep-rooted  human  instinct.  In  the 
advocacy  of  socialistic  organization,  the  advantages  of  unified 
supply  are  much  dwelt  on.  But  the  consumer  in  the  socialist 
state  would  have  to  accept  whatever  the  all-controlling  public 
managers  put  before  him.  The  satisfaction  which  comes  from 
freedom  of  choice  explains  in  large  part  the  persistence  of 
competition. 

The  movement  toward  combination  has  been  so  conspicu- 
ous of  late  years  that  the  extent  of  the  field  which  it  covers  has 
been  exaggerated.  Agriculture  shows  it  least ;  transportation, 
especially  by  land,  shows  it  most.  In  mining,  there  is  the 
striking  case  of  the  iron  trade ;  and  there  is  also,  in  the  United 
States,  the  striking  case  of  anthracite  coal,  where  the  strictly 
limited  area  of  supply  and  the  close  connection  with  transpor- 
tation have  brought  about  effective  combination.  Nevertheless, 
most  mining  is  still  carried  on  by  independent  producers.  In 
manufactures,  most  industries  have  not  reached  the  stage  of 
combination.  Over  the  greater  part  of  the  industrial  field, 
though  production  tends  to  be  on  a  larger  scale,  with  great  use 
of  machinery  and  minuter  division  of  labor,  competition  still 
prevails. 


CHAPTER  5 

CAPITAL 

§  1.  The  increasing  complexity  of  the  division  of  labor  and 
the  growing  use  of  machinery  have  added  to  the  number  of 
separate  stages  in  production  and  to  the  length  of  time  over 
which  the  whole  process  is  spread.  Hence  the  greater  need  of 
a  supply  of  tools  and  materials,  the  importance  of  capital,  the 
problems  which  relate  to  owners  of  capital  and  to  the  income 
from  capital. 

Production  is  spread  over  time  in  any  society  advanced 
beyond  the  most  primitive  savagery;  and  this  not  merely  for 
the  several  subdivided  steps  in  production,  but  for  production 
as  a  whole.  That  agriculture  takes  time,  from  the  sowing  of 
the  seed  to  the  reaping  of  the  crop,  is  obvious.  But  the  sowing 
is  not  the  beginning,  nor  is  the  reaping  the  end.  The  seed 
must  have  been  itself  sown  and  husbanded,  and  the  tools  for 
cultivation  must  have  been  prepared  in  advance.  After  the 
harvest,  the  grain  which  is  reaped  may  indeed  be  available  for 
satisfying  human  needs  almost  at  once;  it  is  so  in  a  small, 
self-contained  community,  such  as  we  still  see  in  a  village  of 
Hindustan.  But  in  the  countries  of  advanced  civilization 
grain  is  carried  by  rail  or  water  to  a  mill,  probably  distant; 
there  ground  into  flour;  then  carried  another  distance  to  dealers ; 
and  finally,  after  a  considerable  interval,  put  into  the  hands  of 
the  consumer.  Each  of  these  steps  not  only  takes  time  in 
itself,  but  implies  the  existence  of  apparatus  which  has  been 
made  in  the  past  and  has  taken  time  to  make,  —  the  railway 
or  steamship,  the  flour  mill,  the  warehouses  and  shops  of  the 
middlemen.  Almost  all  the  operations  of  production  require 
first  the  procuring  of  materials  from  nature's  resources,  then 
their  fashioning  with  the  aid  of  tools  and  machinery.  Let  the 

67 


68  THE  ORGANIZATION  OF  PRODUCTION 

reader  but  consider  the  mode  in  which  the  familiar  articles  of 
daily  use  have  come  into  his  hands,  —  the  clothing  and  the 
footgear,  the  furniture  and  household  utensils,  the  books  and 
ornaments,  the  house  in  which  he  dwells,  —  and  he  will  see 
how  long  has  been  the  series  of  operations,  how  intricate  the 
division  of  labor  for  each  one,  and  how  extended  the  period 
from  the  beginning  of  production  to  the  final  attainment  of 
the  consumable  or  enjoyable  article. 

This  fundamental  fact,  resting  oh  the  complex  division  of 
labor,  is  yet  disguised  by  that  very  division.  The  tanner  who 
puts  his  leather  on  the  market,  the  farmer  who  sells  his  flax, 
the  ironmaster  who  sells  his  steel  or  iron,  each  thinks  of  him- 
self as  marketing  a  completed  product.  By  the  sale  he  gets 
money,  and  so  the  command  of  the  enjoyable  things  he  wishes 
to  buy  or  of  the  things  needed  for  continuing  production.  He 
never  stops  to  reflect  what  must  further  be  done  to  the  thing 
which  he  sells ;  how  it  must  pass  through  the  hands  of  a  long 
chain  of  producers  and  dealers  before  it  reaches  in  consumable 
form  those  whose  wants  are  finally  satisfied. 

In  modern  times,  the  most  significant  aspect  of  this  element  of 
time  in  production  is  found  in  the  increasing  use  of  machinery 
and  plant  of  all  sorts.  Machinery,  though  it  may  be  simply  a  more 
intricate  kind  of  tool,  adds  so  much  to  the  preparatory  work  that 
it  has  greatly  accentuated  the  problems  that  arise  from  the 
spreading  of  production  over  time.  A  factory  requires  a  year 
or  years  to  build ;  the  machinery  in  it  requires  still  more  time 
to  make.  Many  years  are  needed  for  constructing  a  railway ; 
a  generation  for  such  a  work  as  the  Suez  Canal  or  the  Panama 
Canal.  The  factory,  and  the  machinery  in  it,  exist  for  the  pur- 
pose of  eventually  turning  out  things  to  be  used  and  enjoyed. 
The  railway  and  canal  facilitate  the  geographical  division  of  labor, 
and  serve  to  promote,  through  a  series  of  steps  which  only  begin 
when  these  means  of  transportation  have  been  completed,  the 
eventual  abundance  of  things  to  be  used  and  enjoyed.  One 
simple  fact  illustrates  how  marked  the  tendency  toward  greater 
use  of  plant  has  been  in  the  period  since  the  industrial  revolu- 


CAPITAL  69 

tion  began.  The  world's  annual  production  of  iron  has  multi- 
plied tenfold  the  last  half  century,  and  sixtyfold  in  the  last  cen- 
tury.1 Iron  is  used  solely  (the  exceptions  are  insignificant)  as  an 
instrument  of  production;  it  is  the  foundation  of  the  material 
apparatus  of  civilization;  it  means  plant,  tools,  machinery. 
The  enormous  quantities  of  it  which  have  been  turned  out  in 
modern  times,  and  especially  during  the  last  generation,  signify 
an  extraordinary  increase  in  the  construction  of  elaborate  and 
expensive  apparatus,  and  a  corresponding  extension  of  time  in 
the  operations  of  production. 

§  2.  If  we  were  to  take  a  cross  section  of  the  community's  pos- 
sessions at  any  given  time,  we  should  find  them  to  be  of  the  most 
diverse  sort.  There  would  be,  in  the  first  place,  such  things  as 
iron  ore  and  steel  bars,  timber  and  wool  and  cotton,  factories 
and  railways  and  ships,  stocks  of  all  sorts  in  warehouses,  com- 
modities ready  for  sale  in  the  retailers'  shops.  And  in  the  second 
place,  there  would  be  houses,  furniture,  clothing  and  food,  in  the 
hands  of  those  using  them  for  the  satisfaction  of  wants.  To  the 
first  set  of  things  we  apply  the  term  capital,  or  producer's  capital; 
the  second  set  we  call  consumer's  capital,  or  wealth  that  is  not 
capital.  The  first  set  we  may  speak  of  as  unfinished  goods,  the 
second  set  as  finished  and  enjoyable  goods.  For  some  purposes 
of  economic  analysis  they  are  similar,  for  other  purposes  dis- 
similar. The  difference  between  them  is  at  bottom  only  a  dif- 
ference of  degree;  yet  is  so  great  as  to  justify  a  distinction.2 
For  the  present,  we  shall  find  it  convenient  to  apply  the  term 
"  capital "  specifically  to  the  first  set,  —  to  producer's  capital. 
The  second  set  will  be  referred  to  as  enjoyable  or  consumable  or 
finished  commodities;  and  only  when  speaking  of  them  in 

1  The  world's  annual  output  of  pig-iron  was  :  — 

In  1800 825,000  tons 

In  1850 4,750,000  tons 

In  1870 11,900,000  tons 

In  1905 53,700,000  tons 

1  The  difference  in  degree  is  one  as  to  the  time  when  satisfaction  or  utility 
accrues.  That  time  is  commonly  nearer  in  the  case  of  consumer's  wealth  or  con- 
sumer's capital,  and  mora  distant  in  the  case  of  producer's  capital.  See  what 
is  said  below  on  these,  subjects,  Book  V,  Chapter  40. 


70  THE  ORGANIZATION  OF  PRODUCTION 

those  aspects  and  relations  which  offer  analogies  to  the  first, 
shall  we  refer  to  them  as  consumer's  capital. 

Capital,  then,  —  that  is,  producer's  capital,  —  is  not  in  en- 
joyable form ;  it  is  not  now  a  source  of  satisfaction.  It  exists 
for  the  purpose  of  increasing  consumer's  wealth.  Its  relation 
to  enjoyable  goods  is  twofold.  On  the  one  hand,  it  may  be  said 
gradually  to  "  ripen"  into  such  goods.  On  the  other  hand,  it  is  a 
means  of  increasing  their  supply. 

It  is  easy  to  see  that  raw  materials,  as  they  are  commonly 
called,  ripen  into  finished  commodities.  Wool  is  converted  by 
successive  steps  into  clothing,  stone  and  timber  into  a  house, 
grain  into  bread.  But  a  process  the  same  in  essentials  takes 
place  as  to  tools  and  machinery.  Suppose  a  printing  machine 
to  last  for  one  year  only,  being  worn  out  and  worthless  at  the 
close  of  the  year.  The  books  printed  with  its  aid  are  the  product 
not  only  of  the  labor  applied  to  making  the  paper  and  other 
materials,  of  that  applied  by  the  compositors  and  other  workmen 
in  the  printing  office,  but  also  of  that  applied  in  the  construction 
of  the  printing  machine  itself.  If  we  suppose  that  one  hundred 
books  are  printed  in  the  course  of  the  year,  the  machine  may  be 
said  to  have  ripened  into  so  m&ny  enjoyable  goods,  and  each  of 
these  may  be  said  to  have  embodied  in  it  one  hundredth  of  the 
labor  which  was  given  to  constructing  the  machine.  The  ma- 
chine as  such  has  disappeared,  just  as  the  paper  and  ink  as  such 
have  disappeared ;  in  place  of  all  three  we  have  the  printed 
books.  If  the  machine  lasts  for  ten  or  twenty  years,  the  labor 
of  constructing  it  contributes  to  making  a  much  greater 
quantity  of  books,  and  a  smaller  fraction  of  the  labor  of  construc- 
tion is  embodied  in  each  book.  So  of  all  machinery  and  all 
plant.  It  wears  out  sooner  or  later,  and  may  be  said  sooner  or 
later  to  ripen  into  goods  that  satisfy  our  wants. 

The  most  important  single  cause  of  the  abundance  of  con- 
sumable goods,  and  so  of  the  improvement  in  the  material  welfare 
of  mankind,  is  found  in  those  forms  of  capital  which  are  com- 
monly spoken  of  as  fixed,  —  in  tools,  machinery,  plant.  Cer- 
tainly this  has  been  the  most  important  cause  of  the  remark- 


CAPITAL  71 

able  advance  in  material  welfare  which  the  civilized  countries 
have  made  during  the  last  century.  Erect  a  great  cotton  or 
woolen  mill,  a  shoe  factory,  a  large  sugar  refinery  or  flour 
mill,  —  take  much  time  and  apply  much  labor  for  getting  ready 
an  elaborate  apparatus,  —  and  eventually  you  will  secure  your 
product  in  greater  abundance  and  with  less  labor  embodied  in 
each  unit.  The  making  of  machinery  itself  has  illustrated  this 
tendency  as  strikingly  as  any  other  branch  of  production. 
The  manufacture  of  iron  and  steel,  conducted  on  a  great  scale, 
with  elaborate  and  expensive  plant,  serves  to  turn  out  in  cheap- 
ness and  abundance  the  metal  indispensable  for  the  apparatus 
of  production  at  large.  Locomotives,  textile  machinery,  ag- 
ricultural implements,  not  to  mention  the  simpler  tools  of  the 
mechanic,  are  themselves  made  with  machinery. 

In  order  that  all  this  application  of  plant  may  work  smoothly 
and  effectively,  the  supply  of  materials  must  also  have  been 
on  a  large  scale ;  and  this  again  involves  prolonged  preparation. 
A  great  iron  furnace,  kept  in  blast  night  and  day,  year  in  and  year 
out,  takes  into  its  maw  huge  quantities  of  iron  ore,  coal,  and 
limestone,  which,  no  less  than  the  furnace  itself,  must  be  made 
ready  in  advance.  So  the  textile  mill  requires  its  wool  or  cot- 
ton or  silk,  the  shoe  factory  its  leather,  the  refinery  its  raw  sugar. 
Through  all  the  complicated  operations  the  trend  is  the  same ; 
elaborate  preparation,  production  spread  over  time,  much  capi- 
tal, eventual  plenty,  and  cheapness  of  the  consumable  goods. 

§  3.  In  order  that  there  shall  be  capital  and  time-using  pro- 
duction, there  must  have  been  at  some  previous  period  a  surplus. 
The  more  of  capital  is  to  be  employed,  the  more  must  there  be  a 
surplus  to  draw  on. 

In  the  very  earliest  stages  of  the  formation  of  capital,  that 
surplus  showed  itself  directly  in  the  fact  of  spare  time.  The 
first  rude  implements  of  stone  and  bronze  must  have  been 
fashioned  during  hours  when  labor  did  not  need  to  be  given  for 
the  satisfaction  of  imperative  wants,  —  when  there  was  a  chance 
of  doing  something  else.  What  motives  may  have  influenced 
man  during  this  stage,  and  by  what  chance  the  first  tools  were 


72  THE  ORGANIZATION  OF  PRODUCTION 

hit  on,  we  cannot  guess.  Very  possibly  a  mere  instinct  of  con- 
trivance was  the  moving  cause.  A  reasoned  understanding  of 
the  gain  from  having  tools  and  supplies  must  have  set  in  at 
an  early  stage.  The  choice  under  the  simplest  conditions  is 
between  the  present  and  the  future,  —  between  idleness  or 
amusement  for  the  moment  and  provision  for  future  needs. 

The  greater  the  surplus,  the  greater  the  time  and  labor  which 
can  be  given  for  future  needs.  When  the  arts  are  at  so  low  a 
stage  that  little  is  produced  beyond  the  bare  necessaries  of  ex- 
istence, provision  for  the  future  can  be  made  only  on  a  scanty 
scale.  On  the  other  hand,  the  very  scantiness  of  capital  is  an 
obstacle  to  the  efficiency  of  labor  and  so  to  the  existence  of  any 
considerable  surplus.  During  long  ages  mankind  was  thus  in  a 
position  of  double  difficulty.  Without  capital  the  productiveness 
of  labor  was  meager,  and  yet  with  meager  productiveness  of 
labor  there  was  little  possibility  of  creating  more  capital. 

It  is  not  to  be  understood  that  the  slenderness  of  the  surplus 
stock  was  the  only  obstacle  to  the  creation  of  capital.  Igno- 
rance of  natural  laws  and  of  the  possibilities  of  tool  making, 
carelessness  for  the  future,  were  no  less  important.  But  with- 
out the  surplus  the  very  foundation  for  building  up  any  effec- 
tive apparatus  of  production  was  lacking.  Here,  as  often,  the  first 
step  was  the  hardest.  Once  man  had  become  possessed  of  some 
capital,  the  productiveness  of  his  labor  became  greater,  and 
thereby  the  creation  of  still  more  capital  became  easier. 

§  4.  In  the  preceding  section  we  have  spoken  of  capital  as 
being  made  or  created.  But  capital  is  also  said  to  be  saved  and 
accumulated.  Both  expressions  are  accurate.  If  we  think  of 
one  person  or  set  of  persons  as  being  alone  concerned  with  the 
steps  by  which  capital  comes  into  existence,  we  can  see  that 
this  person  both  provides  for  the  future  by  saving,  and  uses  his 
surplus  in  shaping  tools  or  getting  together  materials.  But  in  a 
society  having  an  elaborated  division  of  labor,  these  two  things 
are  rarely  done  by  one  person ;  that  is,  they  are  rarely  done 
together  by  one  person  for  any  given  item  of  capital.  When 
all  incomes  and  expenditures  take  the  form  of  money,  savings 


CAPITAL  73 

are  made,  not  by  putting  aside  things  in  kind  for  one's  own  use, 
but  by  putting  aside  money  for  future  needs.  On  the  other 
hand,  tools  and  other  apparatus  of  production  are  made  for  the 
market  by  persons  who  are  not  consciously  providing  for  the 
future.  They  are  bought  by  other  persons  who  wish  to  "  invest," 

—  that  is,  to  get  capital.     The  process  by  which  these  separate 
steps  are  made  to  bring  about  their  joint  result  in  the  modern 
organization  of  industry  deserves  careful  consideration. 

Saving  may  take  the  form  of  simple  hoarding.  The  miser 
who  puts  away  a  store  of  coin,  saves  and  provides  for  his  own  or 
others'  needs.  But  no  addition  to  the  apparatus  of  production 
results  from  such  saving.  Where  property  is  insecure,  from  the 
rapacity  of  a  despot  or  from  the  feebleness  of  a  government  unable 
to  protect  against  foreign  invaders,  hoarding  is  sometimes  done 
on  a  large  scale.  In  British  India,  during  many  centuries  pre- 
ceding the  British  occupation,  both  these  causes  of  insecurity 
existed.  Hence  those  who  had  means  put  them  largely  into  the 
form  of  specie  and  jewels,  —  articles  having  much  value  in  little 
bulk  and  capable  of  being  hid  or  carried  away.  The  European 
aggressors  of  the  seventeenth  or  eighteenth  century  found  great 
stores  of  such  wealth  in  Hindustan,  not  because  that  country 
had  rich  mines,  but  because  the  people  had  attained  a  consider- 
able civilization  and  prosperity,  and  had  hoarded  long.  Not- 
withstanding the  peace  and  security  which  British  rule  has 
long  maintained,  the  habit  of  putting  accumulated  means  into 
this  form  has  continued  in  India  to  our  own  time.  In  France, 
for  a  long  period  preceding  the  French  Revolution,  the  peasantry 

—  those  among  them,  comparatively  few,  who  had  anything  at 
all  in  the  way  of  a  surplus  —  put  away  coins,  one  at  a  time,  hid- 
den in  the  chimney  or  garret,  until  they  had  accumulated  enough 
to  buy  a  scrap  of  land.     Fear  of  spoliation  and  ignorance  of  other 
ways  of  doing  anything  with  the  money  caused  their  saving  to 
take  the  form  of  hoarding.     No  addition  to  capital  was  thereby 
promoted.     Nor  was  there  any  addition  to  capital  even  when  the 
accumulated  coins  were  brought  out  for  the  purchase  of  land. 
The  noble  of  whom  the  purchase  was  made  probably  frittered 


74  THE  ORGANIZATION  OF  PRODUCTION 

away  the  proceeds,  and  the  only  immediate  result  of  the  peas- 
ant's accumulation  was  the  transfer  of  land  from  one  hand  to 
another.  Such  practises  continued  in  France  after  the  Revolu- 
tion and  until  the  latter  part  of  the  nineteenth  century,  when 
the  war  between  France  and  Germany,  which  shook  so  many  of 
the  established  traditions  of  France,  served  largely  to  bring 
to  an  end  the  habit  of  putting  aside  hoards  of  specie. 

The  great  bulk  of  saving,  however,  takes  in  modern  times  the 
form  of  investment.  Contrast  the  process  of  hoarding  with  what 
happens  when  money  is  put  away  in  a  savings  bank,  —  an  opera- 
tion which  we  may  select  as  typical  of  the  methods  of  investment 
in  a  modern  community.  The  person  who  leaves  his  cash  with 
the  savings  bank  commonly  thinks  only  that  it  is  safe,  and  that 
he  is  paid  something  as  interest  on  it.  But  the  cash  is  not  kept 
in  the  coffers  of  the  institution.  A  small  fraction  only  is  re- 
tained, to  meet  possible  calls  of  depositors  who  wish  to  make 
withdrawals.  Almost  all  of  it  is  lent  out  to  persons  who  use  it 
for  making  a  profit.  Now  profit  arises,  in  the  ordinary  course  of 
things,  from  the  operations  of  production ;  and  the  person  who 
borrows  money  uses  it  for  the  purchase  of  things  needed  in  pro- 
duction. He  may  be  a  manufacturer,  who  erects  a  building, 
buys  machinery  and  supplies,  hires  workmen.  He  may  be  a 
merchant,  who  buys  commodities  from  the  manufacturer,  and 
carries  them  one  stage  further  in  the  successive  stages  which 
bring  them  at  last  to  the  consumer.  Every  person  who  directs 
production  —  such  as  the  manufacturer  or  merchant  —  uses 
a  large  part  of  his  means  in  buying  materials  or  tools  or  stores 
from  producers  of  a  previous  stage,  so  recouping  them  for  the 
outlays  they  have  already  made.  The  money  means  which  are 
put  at  the  disposal  of  the  business  class  as  a  whole  are  a  most  im- 
portant part  of  the  mechanism  for  adding  to  the  concrete  appa- 
ratus of  production. 

§  5.  The  fundamental  fact  in  this  elaborate  mechanism  of 
saving  and  investment  is  that  advances  are  made  to  laborers. 
One  set  of  persons  put  aside  money  means;  through  various 
channels,  other  persons  are  given  command  of  these  money 


CAPITAL  75 

means,  and  use  them  to  set  laborers  to  work.  Here,  again,  the 
division  of  labor  between  those  who  carry  on  the  successive 
stages  of  production  conceals  the  essential  nature  of  their  opera- 
tions. A  manufacturer  spends  only  a  part  of  his  means  upon 
hiring  laborers  directly ;  the  rest  he  uses  in  buying  plant  and  ma- 
terials and  in  the  ^JV>^r  expenses  of  production.  But  those 
materials  were  themselves  fashioned  by  laborers  to  whom 
another  set  of  advances  had  to  be  made  by  a  previous  capitalist. 
The  wholesale  or  retail  merchant  hires  comparatively  few 
laborers,  —  only  a  set  of  clerks  and  a  porter  or  two.  But  he 
recoups  by  his  purchases  of  goods  the  advances  of  a  long  series  of 
preceding  employers,  himself  giving  only  the  finishing  touches  in 
the  whole  process.  Looking  at  the  operations  of  capitalists  and 
employers  as  a  whole,  and  reflecting  on  the  outcome  of  the  divi- 
sion of  labor  among  them  and  their  workmen,  we  find  that  all 
capital  is  made  by  labor,  and  all  the  operations  of  the  capitalist 
class  are  resolvable  into  a  succession  of  advances  to  laborers. 

These  advances,  just  spoken  of  as  money  turned  over  to  la- 
borers, consist  ultimately  in  a  provision  of  commodities  for  their 
use.  The  money  is  but  the  medium  whereby  laborers  get  com- 
mand of  the  commodities  which  they  buy.  These  commodities 
—  things  to  eat,  to  wear,  to  give  shelter  —  are  in  the  last  analysis 
what  the  employing  class  hands  over  to  those  whom  it  employs. 
Some  of  the  advances  were  made  in  the  past,  and  are  repre- 
sented now  by  plant  and  materials,  still  in  use,  of  which  the  full 
equivalent  has  not  yet  been  reproduced  in  finished  form.  Some 
are  made  from  day  to  day,  in  the  course  of  current  operations. 
The  whole  of  existing  capital  may  thus  be  described  as  a  great 
accumulated  surplus  which  has  been  used  and  is  being  used  for 
maintaining  labor,  while  provision  is  made  for  the  future.  The 
process  of  setting  laborers  to  work  in  the  initial  stages  of  pro- 
duction is  going  on  all  the  time ;  similarly  that  of  bringing  arti- 
cles to  the  final  stage  of  consumable  form. 

The  wide  separation,  in  modern  societies,  of  the  two  acts 
needful  for  the  creation  of  capital  —  saving  and  the  application 
of  labor  —  is  mainly  the  result  of  inequality.  Persons  of  the 


76  THE  ORGANIZATION  OF  PRODUCTION 

well-to-do  class  have  a  considerable  surplus  over  current  needs, 
and  save  with  comparative  ease.  They  own  most  of  the  appa- 
ratus of  production.  But  most  persons  in  our  modern  societies 
are  not  of  the  well-to-do  class,  and  have  little  in  the  way  of  a 
surplus.  They  have  small  accumulations,  and  they  are  mainly 
hired  by  others  in  carrying  on  the  operations  of  time-consuming 
production,  and  in  making  and  maintaining  capital.  No  doubt, 
some  savings  are  made  by  the  working  classes;  and  through 
the  agency  of  savings  banks  and  similar  institutions,  these 
savings  have  increased  rapidly.  But,  while  absolutely  con- 
siderable, they  are  no  large  proportion  of  the  total  of  accu- 
mulated means.  The  greater  part  of  the  capital  owned  and 
maintained  in  modern  communities  arises  from  the  savings  of 
the  comparatively  small  numbers  of  the  more  fortunate  classes. 
A  chain  of  middlemen  commonly  connects  the  individual  who 
saves  with  the  laborer  to  whom  advances  are  made.  The  em- 
ployer himself,  though  he  almost  always  uses  some  means  of  his 
own,  commonly  is  a  borrower.  He  borrows,  however,  not  from 
the  savers  directly,  but  from  their  various  agents  and  repre- 
sentatives. The  savings  bank,  for  example,  collects  surplus 
sums  from  individual  savers,  yet  often  deals  with  the  em- 
ployer of  labor  only  through  brokers  and  other  middlemen. 
It  buys  stocks  and  bonds  from  brokers  and  banking  firms. 
The  banking  firms  have  issued  them  after  long  negotiations 
with  the  persons  undertaking  the  operations  to  which  the 
whole  series  of  transactions  is  in  the  end  directed.  Bankers 
are  the  typical  intermediaries;  their  essential  function  is  to 
direct  the  stream  of  surplus  money  income  into  one  direction  or 
another,  and  to  put  into  the  control  of  one  or  another  group 
of  employers  the  means  for  setting  laborers  to  work.  Life 
insurance  companies,  which  collect  and  equalize  funds  put 
aside  by  many  individuals  in  order  to  provide  for  future  needs, 
are  among  the  great  modern  agencies  of  saving.  Like  the 
savings  banks,  they  commonly  make  their  investments  not  by 
direct  loans  to  employers,  but  through  bankers  and  other 
intermediaries  who  take  the  first  risks  of  production  and  guaran- 


CAPITAL  77 

tee  the  investors  a  secure  return.  During  the  last  half  cen- 
tury there  has  been  an  immense  increase  in  the  amount  of 
savings  and  investments  by  persons  who  themselves  are  neither 
desirous  nor  competent  to  direct  actively  the  operations  of 
production.  Hence  there  has  been  a  great  development  of  the 
class  of  middlemen  who  intervene  between  them  and  the 
active  managers;  there  have  been  great  possibilities  of  profit 
for  those  middlemen,  great  possibilities  of  abuse  in  positions  of 
trust,  but  also  great  effectiveness  in  collecting  and  investing 
the  savings  that  underlie  the  enormous  growth  in  the  total 
capital  of  modern  communities. 

§  6.  Not  only  the  creation  of  capital  involves  labor  and 
saving;  its  maintenance  does  so  also. 

All  forms  of  material  wealth  wear  out  in  course  of  time. 
Some  sorts  of  capital  are  indeed  very  durable,  such  as  irrigation 
dams  and  ditches,  or  granite  docks.  Some  last  a  considerable 
time,  as  buildings  and  machinery.  Others  are  used  up  very 
quickly,  as  the  coal  which  is  consumed  under  the  boiler.  All 
need  to  be  replaced  as  time  goes  on ;  some  slowly,  in  proportion 
as  they  last  long;  some  quickly,  in  proportion  as  they  are 
rapidly  used  up.  In  order  that  the  existing  apparatus  of  pro- 
duction may  be  maintained,  a  certain  amount  of  labor  must 
steadily  be  given  to  its  renewal  and  replacement.  This  labor 
must  be  supported,  and  its  support  means  repeated  demand 
upon  surplus  and  savings. 

The  manner  in  which  this  takes  place  may  be  illustrated  by 
the  depreciation  account  which  appears  on  the  books  of  every 
manufacturing  enterprise.  The  manufacturer  knows  that  his 
machinery  wears  out,  and  that,  if  his  capital  is  to  remain  un- 
impaired, he  must  set  aside  something  annually  to  replace  it. 
Not  only  does  his  machinery  wear  out,  but,  in  a  period  of  rapid 
improvement  and  invention  like  our  own,  it  fast  becomes 
antiquated,  and  he  must  be  prepared  for  the  possibility  of  hav- 
ing to  discard  it  even  before  it  has  ceased  to  be  workable.  If 
we  assume  that  its  life  is  ten  years,  he  must  set  aside  annually 
something  like  one  tenth  of  its  value ;  to  put  it  more  exactly, 


78 

he  must  put  aside  such  sums  as,  invested  and  compounded, 
will  make  up  the  value  at  the  close  of  the  decade.  If  he  is  to 
secure  a  permanent  profit,  he  must  reckon  these  amounts  as 
part  of  his  expenses.  Yet,  in  the  first  instance,  the  amounts 
are  free  sums,  or  so  much  surplus,  not  expected  to  be  used  for 
current  expenses.1  They  are  presumably  used  for  purchasing 
new  apparatus  to  replace  that  worn  out;  but  they  are  not 
necessarily  so  used. 

Commonly,  capital  is  maintained  intact;  not  in  the  sense 
that  the  same  machinery  or  materials  are  maintained  indefi- 
nitely, but  in  the  sense  that,  as  they  wear  out,  other  ma- 
chinery and  materials  are  regularly  produced  to  take  their 
place.  The  surpluses  which  are  put  aside  to  balance  deprecia- 
tion are  again  invested  in  the  same  enterprise  and  the  same 
instruments,  or  in  some  other.  The  habit  of  saving  is  strongly 
intrenched  among  the  well-to-do.  Spendthrifts  are  rare,  and 
such  extravagances  as  occur  are  more  than  balanced  by  the  fresh 
accumulations  of  new  savers  and  investors.  Consequently  the 
making  of  new  capital  —  of  machinery,  materials,  and  all  sorts 
of  apparatus  —  goes  on  constantly.  Those  persons  who  in 
the  established  division  of  labor  are  engaged  in  the  machine- 
making  trades,  have  the  well-founded  expectation  that  their 
apparatus  will  be  bought  to  replace  that  which  has  worn  out. 
Thus  the  manufacturer  finds  new  machines  already  prepared, 
or  at  least  finds  all  the  materials  ready  to  be  put  together  by 
other  machinery  made  ad  hoc.  Under  the  division  of  labor, 
provision  is  constantly  made  for  anticipated  needs,  and  among 
those  needs  that  of  replacing  of  capital  steadily  makes  itself  felt. 

The  repair  of  capital,  as  well  as  its  complete  replacement 

1  In  practise,  the  actual  setting  aside  of  money,  and  its  investment  over  a 
term  of  years,  as  a  separate  fund  toward  depreciation,  is  probably  rare.  Usu- 
ally, a  sum  is  each  year  debited  on  the  books  against  earnings,  for  deprecia- 
tion. On  the  other  hand,  one  or  another  item  of  plant  is  renewed  or  repaired 
each  year  —  the  whole  does  not  become  useless  at  one  fell  swoop  —  and  the  sums 
spent  for  replacement  are  charged  against  the  depreciation  account.  In  any 
given  year,  more  or  less  may  be  actually  so  spent  than  is  regularly  set  aside  for 
depreciation.  If  less  is  spent,  and  the  depreciation  fund  accumulates,  it  is 
often  used,  in  a  profitable  enterprise,  for  putting  in  additional  machinery  or 
improvements,  —  it  is  invested  in  the  plant  rather  than  for  the  plant. 


CAPITAL  79 

when  worn  out,  calls  for  the  recurrent  exercise  of  saving.  Some 
kinds  of  apparatus  must  be  touched  up  a  little  from  day  to 
day  in  order  to  be  in  good  working  order.  Such  is  the  case 
with  the  roadbed  of  a  railway,  which  needs  almost  hourly 
attention,  and  would  become  quite  unusable  if  neglected  for 
a  few  weeks.  The  locomotive  of  a  railway,  again,  is  subjected 
to  constant  heavy  strain,  and  needs  to  be  sent  to  the  machine 
shop  at  frequent  intervals;  until  finally,  after  perhaps  a  gen- 
eration of  alternate  using  and  patching,  it  goes  to  the  scrap 
heap,  and  has  to  be  replaced  with  a  new  one.  The  continued 
maintenance  of  capital  by  operations  of  this  sort  means  the 
steady  application  of  labor  hired  (in  the  last  resort)  by  persons 
who  mean  to  keep  their  capital  intact. 

§  7.  Even  at  this  early  stage,  some  corollaries  from  the 
propositions  as  to  capital  and  saving  may  be  stated.  Saving 
on  a  large  scale  is  commonly  undertaken  not  merely  to  provide 
for  future  wants,  but  in  the  expectation  of  a  separate  reward 
in  the  form  of  interest  on  capital.  The  theory  of  interest, 
which  has  many  complications,  will  be  considered  in  its  due 
place;  it  suffices  here  to  say  that,  under  a  regime  of  private 
property,  the  receipt  of  some  such  return  on  savings  is  a  con- 
dition of  the  creation  and  maintenance  of  the  whole  stock  of 
capital.  Some  economists  have  indeed  implied  that  it  is  only 
the  first  making  of  capital  that  calls  for  the  deliberate  use  of 
a  surplus,  and  that  capital,  once  made,  reproduces  itself  auto- 
matically without  any  effort  on  the  owner's  part,  and  without 
any  need  of  stimulus  or  resource  in  the  way  of  interest.1  This 
view  arises  from  assuming  that  what  is  habitually  done  is  done 
without  choice  or  effort.  The  habitual  replacement  of  capital 
takes  place  not  by  any  automatic  process,  but  because  the 
owners  recurrently  choose  to  save  and  to  invest  surplus  sums 
as  they  are  acquired.  Were  there  no  motive  for  doing  so  — 
were  there  no  such  thing  as  interest  on  capital  —  habits  would 
change;  and  not  only  the  creation  of  new  capital,  but  the 
maintenance  of  that  already  existing,  would  be  endangered. 

lE.g.  J.  B.  Clark,  The  Distribution  of  Wealth,  Ch.  IX. 


80  THE  ORGANIZATION  OF  PRODUCTION 

Such,  at  all  events,  would  be  the  result  in  communities,  of  the 
kind  familiar  to  us,  in  which  there  is  accumulation  and  owner- 
ship of  capital  by  private  individuals.  What  would  be  the 
method  of  accumulating  capital  under  the  very  different  con- 
ditions of  a  socialist  community,  where  all  capital  was  owned 
by  the  state,  opens  another  set  of  questions,  which  must  be 
reserved  for  later  consideration.1 

§  8.  In  the  older  books  on  economics  it  was  often  laid  clown 
that  the  distinction  between  capital  and  noncapital  was 
merely  a  matter  of  the  owner's  intention.  According  as  he 
chose  between  investing  and  spending,  —  between  providing  for 
the  future  and  enjoying  in  the  present,  —  there  was  capital  or 
there  was  enjoyable  wealth.  The  impression  was  left  that 
some  magic  change  was  wrought  in  the  nature  of  commodities 
by  the  mere  volition  of  their  owner.  Obviously  this  could  not 
be  literally  true.  Most  articles  are  by  their  nature  such  that 
they  can  be  used  only  in  one  way,  —  either  for  present  enjoy- 
ment or  as  producer's  capital.  Iron  and  steel,  for  example,  to 
which  reference  was  made  in  an  earlier  paragraph,  are  almost 
of  necessity  capital.  They  are  used  for  making  tools,  machines, 
buildings,  and  can  rarely  be  used  for  any  other  purpose.  All 
factories  and  all  materials  are  in  the  same  case.  Almost  uni- 
versally any  concrete  form  of  wealth  is  by  its  nature  fit  to  be  used 
once  for  all  either  as  capital  or  as  a  source  of  immediate 
enjoyment. 

Could  the  owner,  nevertheless,  exercise  his  choice  by  selling 
his  capital  (say  a  factory),  and  using  the  proceeds  at  will  for 
investment  or  for  enjoyment?  A  little  reflection  shows  that 
such  a  disposal  cannot  change  the  nature  of  the  factory.  Sale 
means  simply  transfer  to  another  hand;  the  factory  remains, 
and  its  purchaser  can  use  it  only  as  an  instrument  of  produc- 
tion. The  individual  can  change  by  sale  the  nature  of  his 
own  possessions,  but  he  cannot  thereby  change  the  nature  of 
the  apparatus  of  production. 

Nevertheless,  the  owner's  intention  is  in  the  long  run  im- 

1  See  Book  VII,  Chapter  63,  §  5. 


CAPITAL  81 

portant,  nay  decisive,  in  determining  whether  wealth  shall  or 
shall  not  take  the  form  of  producer's  capital.  As  the  various 
kinds  of  wealth  wear  out  and  need  to  be  renewed  or  replaced,  a 
choice  is  recurrently  presented  to  the  owners  as  to  the  way  in 
which  they  shall  use  their  surplus  possessions,  —  whether  they 
shall  continue  investment  and  maintain  capital,  or  cease  in- 
vestment and  cause  labor  to  be  directed  to  making  consumable 
goods.  For  any  given  period  they  may  have  committed  them- 
selves irrevocably  to  investment,  and  cannot  change  the  form 
which  their  property  has  taken.  But  as  time  passes,  and  the 
process  of  using  and  renewing  the  various  kinds  of  wealth  goes 
on,  they  have  again  the  option  which  they  had  in  the  initial 
stages.  They  may  save  and  invest,  or  they  may  spend  and 
enjoy.  However  considerable  the  length  of  time  over  which 
the  capital  of  a  community,  when  once  constructed,  endures  in 
the  shape  which  has  been  given  it,  and  however  slow  the  process 
by  which  the  disposition  of  the  capitalists  takes  effect,  it  is 
still  true  that  in  the  long  run  the  owners'  intention  determines 
whether  there  shall  or  shall  not  be  capital. 

§  9.  Saving  and  investment  have  been  spoken  of  so  far  as 
leading  to  the  making  of  capital.  But  they  do  not  necessarily 
do  so ;  and  some  consideration  of  the  cases  where  they  do  not 
is  essential  to  an  understanding  of  the  relations  of  the  individual 
saver  to  the  general  welfare. 

All  that  the  individual  investor  is  concerned  with  is  the 
safety  of  his  principal  and  the  return  on  it  in  the  way  of  interest. 
If  a  spendthrift  wishes  to  borrow,  and  gives  a  sufficient  guaran- 
tee of  repayment,  by  mortgage  or  other  pledge,  a  loan  is  made 
to  him  as  freely  as  to  a  business  man  who  proposes  to  put  up  a 
factory.  But  the  loan  to  the  spendthrift  has  nothing  to  do 
with  the  making  of  capital.  It  leads  to  the  same  results  as  if 
the  original  owner  of  the  surplus  sums  had  devoted  them  to 
present  use.  It  causes  labor  to  be  directed  to  producing 
truffles  and  champagne,  not  factories  and  machinery. 

Spendthrift  loans,  incurred  by  individuals,  are  common  in 
backward  countries,  but  with  industrial  progress  tend  to  become 


82  THE  ORGANIZATION  OF  PRODUCTION 

relatively  unimportant.  The  Hindu  peasant  still  borrows 
from  the  village  usurer,  as  his  kind  have  done  for  centuries; 
he  will  pledge  his  crops,  his  land,  his  very  self,  to  give  a  feast 
on  the  marriage  of  his  daughter.  During  the  transition  from 
the  Middle  Ages  to  the  modern  period,  kings  and  feudal  digni- 
taries borrowed  heavily  (often  from  the  Jews),  in  part  for 
crusades  and  dynastic  wars,  in  part  to  satisfy  the  developing 
taste  for  lavish  expenditure  of  money  income.  But  in  modern 
times  operations  of  this  sort  have  become  of  little  importance 
as  compared  with  the  total  of  borrowing  and  of  spending. 
Pawnbroking  has  become  a  petty  business.  Most  borrowing 
by  private  persons  takes  place  in  the  course  of  investment. 

Yet  another  kind  of  spendthrift  borrowing  remains  of  great 
economic  importance  —  by  governments  for  war  purposes. 
Where  highways  or  railwaj^s  or  irrigation  works  are  constructed 
from  loans,  we  have  the  ordinary  phenomena  of  saving,  in- 
vesting, capital  making.  But  where  the  sums  advanced  by 
investors  are  used  for  war  expenditures,  we  have  saving  and 
investing,  but  no  resulting  capital.  We  have  vast  waste  by 
contending  armies,  and  great  loans  that  are  —  so  far  as  their 
strictly  economic  consequences  are  concerned  —  essentially  of 
the  spendthrift  sort. 

Every  modern  state  has  a  great  debt,  and  these  debts  repre- 
sent in  the  main  war  loans.  The  national  debt  of  France  now 
amounts  to  some  3000  millions  of  dollars ;  that  of  England  to 
millions.  Both  are  the  legacies  (almost  exclusively)  of  wars. 
The  United  States  borrowed  2500  millions  during  the  Civil  War, 
and  our  war  debt  still  outstanding  (1909)  amounts  to  1000 
millions  of  dollars.  The  consols  and  rentes  and  government 
bonds  by  which  these  debts  are  evidenced  represent  to  the  in- 
dividual investor  the  acme  of  solidity  and  security.  Yet  they 
are  the  most  intangible  of  the  forms  of  wealth.  They  stand 
simply  for  claims  on  the  community  at  large,  —  an  obligation 
by  the  public  to  pay  stated  sums  to  the  creditors.  In  no  sense 
do  they  stand  for  capital  to  the  community. 

This  great  phenomenon  has  a  bearing  on  the  social  signifi- 


CAPITAL  83 

cance  of  interest  as  a  return  on  capital.  Interest  means  a 
leisure  class.  Rightly  or  wrongly,  some  persons  are  supported 
in  idleness  by  the  rest  of  the  community.  Against  the  burden 
may  be  set  the  fact  that  the  community  possesses  useful  in- 
struments which  could  not  have  been  got  except  through  some 
one's  saving.  This  is,  in  essentials,  the  justification  of  interest. 
But  in  the  case  of  national  debts  the  community  has  obtained 
no  useful  instruments.  The  justification  of  the  claim  to  interest 
by  the  public  creditors  themselves  is  of  course  in  no  way  affected 
by  this  consideration.  Their  rights  must  be  held  as  inviolable 
as  those  of  other  lenders.  But  the  social  justification  of  interest 
would  be  much  less  strong  if  all  saving  and  all  investment 
were  for  the  conduct  of  war,  and  if  nothing  of  permanent 
economic  effect  remained  but  endless  generations  of  pensioners. 

§  10.  Some  further  distinctions  as  to  capital  call  for  brief 
consideration. 

An  individual  thinks  that  to  be  capital  which  yields  him  an 
income ;  but  there  is  an  obvious  distinction  between  that  which 
'is  capital  for  the  community  and  that  which  is,  in  the  usual  sense, 
"capital"  to  the  individual. 

Stocks,  bonds,  and  securities  yield  an  income  to  the  owner, 
and  are  regarded  by  him  as  part  of  his  capital.  In  themselves 
these  are  simply  evidences  of  ownership  or  of  indebtedness.  A 
stock  certificate  states  that  the  holder  has  certain  fractions  of 
ownership  in  a  given  concrete  thing  or  set  of  things.  A  bond  is 
a  mere  promise  to  pay.  Bonds  are  commonly  issued  as  the 
result  of  operations  of  saving  and  investing  which  have  to  do 
with  the  making  of  capital.  But,  as  the  case  of  government 
securities  shows,  they  may  be  the  result  of  operations  which  are 
quite  wasteful.  Though  capital  to  the  individual,  they  may  or 
may  not  signify  the  creation  or  the  existence  of  real  capital. 

Consumer's  wealth  is  not  commonly  regarded  by  an  individual 
as  part  of  his  capital.  A  factory ;  a  stock  of  materials  or  goods 
used  in  business  operations;  money  on  hand  or  in  bank,  not 
in  the  nature  of  spare  cash  for  current  expenses,  but  a  fund 
or  reserve  for  business  purposes,  —  such  things  he  thinks  of  as 


84  THE  ORGANIZATION  OF  PRODUCTION 

capital.  Household  furniture,  clothing,  horses  and  carriages, 
he  does  not  so  reckon,  since  these  yield  him  no  income.  Pos- 
sibly a  dwelling,  though  occupied  by  the  owner  and  yielding  no 
direct  income,  would  still  be  regarded  by  him  as  part  of  his 
capital ;  for  he  might  reflect  that,  if  he  did  not  own  it,  he  would 
have  to  hire  one  at  a  rental,  and  hence  might  conclude  that 
his  own  is  equivalent  to  income-yielding  property.  Dwellings 
not  occupied  by  the  owner,  but  let  to  tenants,  would  unques- 
tionably be  regarded  as  capital. 

Everyday  usage  is  hazy,  and  "capital,"  like  other  common 
words,  is  used  in  different  senses.  For  the  purposes  of  economic 
study,  we  shall  disregard  the  individual's  point  of  view,  and  shall 
consider  the  subject  of  capital,  as  we  shall  other  subjects,  from 
the  point  of  view  which  is  important  for  the  community. 
Whether,  so  considered,  there  is  an  important  difference  be- 
tween producer's  and  consumer's  wealth,  will  be  discussed  at  a 
later  stage.1  It  suffices  here  to  say  that  in  speaking  of  capital, 
we  shall  have  in  mind  real  things,  and  not  rights  to  things ;  and 
we  shall  have  in  mind  producer's  capital,  —  those  things  which 
are  part  of  the  community's  apparatus  of  production. 

Some  writers  have  distinguished  between  "capital"  and 
"capital  goods."  By  the  latter  term  they  mean  the  concrete 
apparatus  of  production,  —  just  that  to  which,  in  the  preceding 
paragraph,  the  single  word  "  capital  "  was  affixed.  But  by  the 
word  "capital"  alone  these  writers  mean  the  value  of  the  con- 
crete apparatus;  and  they  sometimes  speak  as  if  there  were 
a  sort  of  distillation  or  essence  of  capital,  distinct  from  the 
tangible  capital  goods  in  which  it  is  embodied. 

It  is  often  convenient  to  measure  and  record  capital  in  terms 
of  value  and  price,  —  as  so  much  money.  In  that  way  alone 
can  the  various  constituent  elements  be  reduced  to  a  common 
denominator.  An  individual  usually  states  his  capital  as  being 
so  much  in  money  value.  His  capital  obviously  consists,  not 
of  the  stated  sum  of  money,  but  of  factories,  machines,  buildings, 
merchandise,  stocks  and  bonds,  if  you  please,  —  the  various 

1  See  below,  Book  V,  Chapter  40,  §  3. 


CAPITAL  85 

things  which  make  up  an  individual's  "capital."  He  simply 
measures  it  in  terms  of  the  price  for  which  the  whole  would  sell. 
Similarly,  we  can  reckon  the  community's  capital  in  terms  of 
the  price  for  which  the  whole  would  sell.  If  the  total  prices,  at 
current  rates,  of  the  various  factories,  instruments,  materials, 
goods  in  stock,  are  added  together,  the  sum  will  give  an  idea  of 
how  much  capital  the  community  possesses.  It  would  give  a 
very  imperfect  idea.  Statistics  of  this  sort,  occasionally  col- 
lected by  public  officials  for  census  purposes,  are  in  many  ways 
misleading.  Yet  if  we  wish  to  measure  total  capital  or  total 
wealth  at  all,  we  can  proceed  only  in  this  unsatisfactory  way. 
Though  some  forms  of  capital  can  be  measured  in  other  terms,  — 
machinery,  for  example,  in  terms  of  horse-power,  or  textile  mills 
in  terms  of  spindles  and  looms,  —  the  only  measurable  element 
common  to  all  forms  is  that  they  have  value  and  price,  and  the 
only  way  of  reaching  a  quantitative  statement  as  to  the  whole 
is  in  terms  of  value  and  price. 

But  it  is  not  to  be  supposed  that  there  is  any  such  thing  as 
capital  distinct  from  the  capital  goods.  The  only  actual  and 
existent  thing  is  the  concrete  apparatus  of  production.  Its 
value  or  price  is  merely  a  relation  to  other  things,  a  mode  of 
measuring  it.  Hence  in  the  following  pages,  we  shall  com- 
monly denote  by  "capital"  the  concrete  things,  or  "capital 
goods."  Sometimes,  it  is  true,  convenience  in  conforming  to 
everyday  terminology  will  require  a  departure  from  this  usage. 
We  shall  have  occasion  to  speak,  for  example,  of  the  capital 
of  a  bank,  which  is  always  reckoned  in  terms  of  money;  and 
in  other  discussions  the  word  may  refer  to  the  values  and  prices 
of  things  rather  than  to  the  things  themselves.  What  sense  is 
meant,  will  ordinarily  be  clear  from  the  context.1 

1For  some  references  on  Capital,  see  below,  at  the  close  of  Book  V 


CHAPTER   6 

THE  CORPORATE  ORGANIZATION  OF  INDUSTRY 

§  1.  The  growth  of  large-scale  operations  has  caused  a  great 
development  of  combined  action  by  producers  and  investors; 
that  is,  by  those  who  guide  production  and  those  who  own  the 
apparatus  of  production.  Association  by  the  manual  laborers 
themselves,  for  the  conduct  of  production,  is  a  different  thing. 
It  might  conceivably  be  an  important  and  even  dominant  form 
of  industrial  organization;  but  in  fact  it  is  not.1  The  form 
which  is  more  important  than  any  other  in  the  modern  world  is 
the  association  in  the  business  corporation  of  capitalist  owners 
and  managers. 

The  simplest  form  of  association  by  such  persons  is  the  part- 
nership of  two  or  more  persons.  The  distinguishing  mark  of 
the  partnership  in  the  eye  of  the  law  was  originally  the  joint  and 
several  liability  of  the  partners  for  all  debts ;  and  this  still  re- 
mains in  most  cases.  Each  of  the  partners  is  liable  individually 
and  without  limit  for  all  debts  of  the  firm.  A  creditor,  if  his 
claim  is  not  met  according  to  stipulation,  may  levy  on  any  one 
of  them,  and  may  secure  the  full  amount  of  his  debt  from  that 
one.  The  mode  in  which  the  partners  then  settle  the  distribu- 
tion of  the  obligation  among  themselves  is  a  matter  with  which 
the  creditor  need  not  concern  himself. 

The  distinguishing  mark  of  the  corporation  is  limited  liability. 
The  several  associated  persons  contribute  to  the  undertaking,  in 
the  form  of  a  subscription  to  shares  or  capital  stock,  a  given 
sum.  Their  liability  for  debts  is  then  limited  in  proportion 
to  the  original  subscription.  Usually  it  is  limited  to  the  pre- 
cise amount  subscribed.  When  they  have  once  paid  in  that 
sum  in  full,  —  the  par  value  of  their  shares,  —  they  can  be 

1  See  what  is  said  in  Book  VI,  Chapter  58,  of  cooperation  by  workingmen. 

86 


THE  CORPORATE  ORGANIZATION  OF  INDUSTRY    87 

s 

called  on  to  pay  no  more.  Occasionally  there  is  a  different 
liability.  For  example,  in  our  national  bank  corporations,  the 
liability  is  double;  the  shareholder  may  be  called  on  to  pay 
not  only  his  original  subscription,  but  (in  case  of  need  for 
meeting  debts)  as  much  more.  Some  limitation  there  always  is. 
The  shareholder  in  a  corporation  is  never  liable,  as  is  a  partner, 
to  the  full  extent  of  his  means. 

The  legal  distinction  between  a  partnership  and  a  corpora- 
tion does  not  run  parallel  with  that  which  is  significant  for  the 
purposes  of  economic  study.  For  the  economist,  the  impor- 
tant distinction  is  between  an  association  of  a  very  few  persons, 
well  known  to  each  other  and  actively  engaged  in  the  under- 
taking, and  an  association  of  a  considerable  number  of  persons, 
strangers  to  each  other  and  generally  investors  not  closely  con- 
cerned with  the  management.  Size,  though  not  necessarily  sig- 
nificant, yet  distinguishes  roughly  the  two  kinds  of  economic 
organization.  It  is  true  that  some  corporations  are  small,  some 
partnerships  large.  But  usually  the  conduct  of  operations  on 
a  considerable  scale,  and  with  a  considerable  number  of  partic- 
ipants, is  in  the  corporate  form;  while  partnerships  usually 
confine  themselves  to  more  moderate  undertakings. 

During  the  last  half  century,  legislation  in  English-speaking 
countries  has  greatly  modified  the  sharp  distinction  which  the 
law  drew  in  earlier  times  between  the  partnership  and  the  cor- 
poration. The  strict  rules  of  the  older  common  law  made  the 
partnership  a  cumbrous  form  of  organization.  It  had  to  be 
wound  up  on  the  death  of  any  partner,  and  it  was  in  other  ways 
hampered  in  continuity  of  operation.  Accordingly  statutes 
have  permitted  partnerships  to  have  some  of  the  characteristics 
of  corporations,  —  continuing  existence,  inactive  members, 
some  limitation  of  liability.  On  the  other  hand,  corporations 
have  been  allowed  to  enter  on  all  sorts  of  industrial  fields  which 
formerly  were  shut  to  them.  Originally,  industrial  corporations 
were  authorized  only  where  some  special  public  interest  was 
supposed  to  be  involved ;  as  in  the  case  of  the  great  companies 
for  foreign  trade  in  the  seventeenth  and  eighteenth  century,  of 


88  THE  ORGANIZATION  OF  PRODUCTION 

banking  corporations,  and,  in  later  days,  canals,  turnpikes, 
railways,  and  the  like.  But  the  convenience  of  this  form  of 
associated  action,  compared  with  the  cumbrousness  of  the  part- 
nership, caused  a  gradual  extension  of  its  field,  until  at  present 
any  and  every  sort  of  industrial  enterprise  may  be  conducted  in 
corporate  form. 

The  consequence  is  that  many  business  corporations  are  of 
small  size,  owned  and  managed  by  a  few  individuals  whose 
relations  to  each  other  are  substantially  those  of  partners.  The 
choice  between  a  corporation  of  this  sort  and  a  partnership  of  the 
older  type  is  often  determined  by  the  peculiarities  of  the  law  in 
the  place  of  action,  by  its  tax  methods,  by  its  legal  procedure. 
The  fundamental  distinction  of  limitation  of  liability  has  ceased 
to  be  of  vital  importance.  It  is  true  that  a  partnership  with  un- 
limited liability  may  be  expected  to  enjoy  better  credit,  since 
those  who  lend  to  it  have  more  to  fall  back  on.  But  credit  in 
modern  times  depends  very  much  on  the  personality  and  busi- 
ness repute  of  the  borrowers ;  or,  if  there  be  question  as  to  their 
business  standing,  it  depends  on  the  direct  pledge  of  property. 
The  other  conveniences  of  corporate  organization  outweigh 
any  disadvantage  on  the  score  of  credit.  Hence  "Smith  & 
Jones,  Incorporated,"  or  "Smith  &  Jones,  Limited,"  or  the 
"Smith  &  Jones  Company,"  supersede  plain  "Smith  & 
Jones";  but  this  change  in  the  legal  form  of  organization  is 
of  little  economic  consequence. 

Very  different,  to  repeat,  is  the  economic  significance  of  what 
we  may  call  the  true  corporation.  Here  there  are  many  share- 
holders, directors  selected  from  among  them,  and  managers 
chosen  by  the  directors,  —  in  other  words,  a  clear  separation 
between  owners  and  managers.  This  is  the  sort  of  organization 
chiefly  found  when  production  takes  place  on  a  very  large  scale. 

In  our  own  time,  and  in  the  United  States,  many  people 
associate  with  the  term  "corporation"  something  still  different ; 
not  only  divided  ownership  and  large-scale  operations,  but 
special  public  importance.  They  think  of  corporations  as  having 
a  monopoly  power,  and  therefore  peculiarly  subject  to  public 


THE  CORPORATE  ORGANIZATION  OF  INDUSTRY    89 

regulation.  "Public  service  corporations"  are  spoken  of  as 
if  they  were  the  corporations.  Whether  there  is  a  clear  line  of 
distinction  between  the  so-called  "public"  corporations  and 
the  others,  and  whether  large-scale  operations  in  themselves 
bring  monopoly  and  public  responsibility,  will  be  considered  in 
another  place.1  For  the  present  we  are  concerned  simply  with 
those  aspects  of  corporate  development  which  have  to  do  with 
the  growth  of  large-scale  production  in  modern  times,  and  with 
the  modern  mechanism  of  saving  and  investment.  Not  only 
corporations  of  the  "public  service"  kind,  but  others  which  are 
commonly  regarded  as  having  no  special  duties  or  relations  of 
a  public  sort,  present  these  aspects.  Hence,  in  the  following 
sections,  we  shall  speak  of  "corporations"  in  the  sense  indicated 
above,  —  those  which  operate  on  a  large  scale,  which  have 
many  shareholders,  and  in  which  investors  and  managers  are 
clearly  separated. 

§  2.  The  advantages  of  the  corporation  for  the  development 
of  industry  have  been  great. 

In  the  first  place,  large-scale  operations  have  been  facilitated. 
Many  modern  enterprises  require  so  great  a  capital  that  no 
individual  could  supply  it.  In  some  of  the  older  books  on 
economics,  it  was  said  that  such  enterprises  could  be  undertaken 
only  by  the  state ;  and  hence  mere  size  was  regarded  as  a  crite- 
rion for  public  management  of  industry.  This  reason  for  re- 
sorting to  public  management  can  now  have  no  force.  Though  no 
individual  or  small  group  of  individuals  be  able  to  furnish  the 
funds  needed,  the  corporate  combination  of  numerous  individ- 
uals can  supply  the  means  for  any  undertaking,  however  large. 

Limitation  of  liability  has  been  a  chief  factor  in  promoting 
large-scale  operations  under  corporate  organization.  Every 
enterprise  involves  risk,  especially  in  its  first  stages.  Where 
the  enterprise  is  large,  the  amount  risked  and  the  consequent 
liability  are  correspondingly  large.  If  each  individual  who 
took  shares  were  liable  for  debts,  as  a  partner  is,  without  a 
limit,  investment  would  be  checked.  Occasionally  it  has  hap- 

»See  Book  VII,  Chapter  6. 


90  THE  ORGANIZATION  OF  PRODUCTION 

pened  that  a  great  business,  conducted  in  essentials  under  cor* 
porate  form,  but  without  the  legal  safeguard  of  limited  liability, 
has  met  reverses  and  failed.  Each  shareholder  has  in  such  a 
case  been  subject  to  levy  for  all  his  property.  Thus  when  the 
Glasgow  Bank  failed  in  1878,  hundreds  of  small  shareholders 
in  Scotland  were  ruined  because  each  was  liable  for  the  debts 
without  limit.  Probably  few  of  them  were  clearly  aware  of  this 
possibility  when  they  became  owners  of  their  shares.  The 
general  practise  of  strict  incorporation  and  consequent  limita- 
tion of  liability  had  put  them  off  their  guard.  If  experience 
like  theirs  were  frequent,  it  would  not  be  possible  to  gather  the 
capital  for  large  enterprises  by  contributions  from  many  scat- 
tered individuals. 

Again,  new  enterprises,  both  large  and  small,  and  especially 
those  which  are  large,  have  been  promoted  by  the  limitation 
of  liability.  The  progress  of  invention  in  modern  times,  the 
diversification  of  industry,  the  increase  of  productive  power,  — • 
all  this  has  taken  place  by  successive  ventures,  each  of  which 
meant  at  the  outset  uncertainty  and  risk.  It  is  comparatively 
easy  to  induce  a  person  to  take  a  few  shares,  or  even  a  good 
number  of  shares,  in  a  novel  undertaking  presenting  possibilities 
of  profit ;  but  if  participation  involves  also  the  possible  loss  of 
his  entire  fortune,  he  will  be  slow  to  join.  Such  a  great  risk  will 
be  taken  only  if  the  possibilities  of  profit  be  very  great  indeed ; 
that  is,  if  the  prices  of  the  commodity  or  service  in  question 
promise  to  be  high  enough  to  yield  an  exceptional  profit.  Limi- 
tation of  liability  and  consequent  readiness  to  invest  in  venture- 
some operations  mean  not  only  that  more  such  operations  will 
be  carried  on,  but  that  the  community  will  get  the  output  on 
better  terms. 

Perhaps  most  important  of  all  the  ways  in  which  corporate 
organization  has  promoted  the  development  of  industry  has 
been  the  ease  of  investment,  and  the  consequent  stimulus  to 
saving  and  the  making  of  capital.  In  the  eighteenth  century 
almost  the  only  possibility  of  investing  in  securities  was  through 
the  purchase  of  public  obligations ;  and  these,  though  they  meant 


THE  CORPORATE  ORGANIZATION  OF  INDUSTRY  91 

investment  by  the  individual,  usually  brought  no  increase  in  the 
community's  capital.  Merchants  and  persons  in  active  bus- 
iness could  indeed  manage  the  investment  of  their  surplus  means 
in  factories,  warehouses,  ships,  and  the  like.  But  the  investor 
pure  and  simple  could  not  turn  to  these.  If  he  did  not  buy 
government  securities,  he  had  little  choice  but  to  buy  and  im- 
prove real  property.  Real  property  is  not  divisible  into  con- 
venient shares,  and  involves  a  good  deal  of  management  and 
not  a  little  risk.  The  modern  security  market,  on  the  other 
hand,  offers  an  almost  limitless  field  for  the  investment  of 
savings,  great  and  small.  Railways,  factories,  steamships, 
mines, — all  are  conducted  under  corporate  form,  and  corporate 
obligations  representing  them  can  be  bought  at  a  moment's 
notice  by  any  one.  Savings  have  been  made  liquid,  so  to  speak, 
and  can  flow  with  ease  and  in  any  desired  volume  wherever 
there  is  a  prospect  of  their  advantageous  use.  The  ease  of 
investment  in  corporate  enterprises  has  stimulated  savings, 
and,  by  a  reciprocal  influence,  the  unceasing  accumulation  of 
savings  has  made  possible  an  immense  increase  of  real  capital 
under  corporate  management. 

§  3.  The  consequences  of  ease  of  transfer  for  corporate  shares 
deserve  special  attention.  It  is  by  no  means  essential  to  cor- 
porate organization ;  for  conceivably  those  who  have  embarked 
as  shareholders  in  a  company  might  bind  themselves  to  stick  to 
it  for  good  or  ill.  But  transferability  is  so  ancient  and  so  nearly 
universal  that  it  is  commonly  thought  of  as  a  natural  and  neces- 
sary part  of  corporate  organization. 

Transferability,  like  limitation  of  liability,  is  advantageous 
for  the  community  in  that  it  makes  possible  a  greater  division  of 
risks.  A  person  who  has  invested  by  taking  shares  in  a  given 
corporation  is  not  thereby  committed  to  the  bitter  end.  If  he 
does  not  think  well  of  its  prospects,  or  comes  across  some  oppor- 
tunity which  he  finds  more  promising,  he  can  sell  his  shares  to 
another  person  who  has  a  better  opinion  than  his  own  of  the 
original  venture.  As  will  be  explained  more  fully  in  the  later 
discussion  of  speculation  and  exchanges,  ease  of  sale  in  any  set 


92  THE  ORGANIZATION  OF  PRODUCTION 

of  business  dealings  facilitates  venturesome  operations,  and 
permits  them  to  be  carried  on  at  a  smaller  margin  of  profit.1 
It  is  so  with  sales  of  securities  and  speculative  operations  on  the 
stock  exchanges.  The  essential  advantage  of  such  transactions 
for  the  public  is  that  they  operate  as  a  sort  of  insurance  against 
risk,  and  so  stimulate  investment,  especially  in  new  enterprises. 

Transferability  of  shares  probably  has  another  advantage. 
It  tends  to  bring  ownership  and  control  into  the  hands  of  the 
shrewd  and  competent.  Those  who  judge  best  of  the  prospects 
of  an  enterprise,  and  who  exercise  influence  intelligently  toward 
its  skillful  management,  buy  out  those  who  are  less  capable. 
Good  judgment  is  perhaps  the  most  important  quality  for  suc- 
cess in  business  operations,  and  tells  immensely  both  for  an  in- 
dividual's money-making  and  for  the  efficient  utilization  of  the 
community's  labor  and  capital.2  Whether  the  reward  which 
such  judgment  secures,  often  so  large  and  so  quickly  won,  is  in 
proportion  to  the  services  rendered,  may  be  an  open  question. 
But  judgment  does  tell  immensely,  and  transferability  of  cor- 
porate shares  aids  in  making  it  tell. 

Transferability,  however,  has  had  some  consequences  that 
are  not  so  clearly  beneficial.  The  sense  of  association  for  com- 
mon ends  has  virtually  disappeared  among  the  shareholders  of 
the  modern  corporation.  Though  it  persists  more  or  less  in  the 
closely  owned  family  corporation  (the  quasi-partnership),  it  is 
gone  where  the  holders  are  many  and  widely  separated.  Each 
looks  out  for  himself;  deserts  the  venture  in  case  of  expected 
loss  as  a  rat  deserts  a  sinking  ship,  or,  if  he  expects  a  gain,  quickly 
gathers  in  from  his  associates  a  larger  number  of  shares  for  his 
own  profit.  To  sell  out  when  the  affairs  of  a  corporation  are 
going  badly,  to  buy  in  when  they  are  going  well,  is  the  height  of 
business  acumen.  This  is  quite  inconsistent  with  the  original 
notion  of  a  joint  venture  for  common  profit  or  common  loss; 
but  it  is  not  for  a  moment  thought  of  as  violating  any  principle 
of  morals  or  of  fair  play.  No  doubt  it  brings  the  advantages 

1  See  Book  II,  Chapter  11. 

8  Compare  Book  V,  Chapter  49,  §  4. 


THE  CORPORATE  ORGANIZATION  OF  INDUSTRY     93 

just  mentioned:  the  constant  buying  and  selling  minimize  risk 
for  the  individual,  and  make  for  control  by  the  shrewd  and  able. 
But  it  is  among  the  phases  of  individualism  that  bring  a  shock  to 
a  nice  moral  sense. 

The  extraordinary  growth  of  corporate  enterprises,  and  the 
transferability  of  their  shares,  have  brought  into  existence  the 
modern  stock  exchanges,  with  all  their  conspicuous  and  some- 
times overshadowing  influences.  The  homogeneity  of  shares 
and  other  securities  makes  them  available  for  purchase  and  sale 
by  all  sorts  of  persons,  and  thus  peculiarly  adapted  for  speculative 
dealings.1  By  far  the  greater  part  of  the  transactions  on  the  ex- 
changes have  nothing  to  do  directly  with  the  process  of  actual 
investment ;  usually  that  has  been  completed  before  the  securities 
are  listed.  It  is  only  in  the  way  of  anticipation,  through  the  in- 
direct influence  of  the  prospect  of  easy  transfer,  that  stock 
exchange  dealings  promote  the  increase  of  factories,  railways,  con- 
crete capital.  Though  the  gain  in  this  way  is  real,  it  is  accompanied 
by  a  vast  deal  of  unproductive  effort  in  the  way  of  stock  gam- 
bling; nor  is  it  easy  to  say  whether  the  social  gain  on  the  whole 
outweighs  the  social  loss.  Most  persons  who  discuss  these  matters 
have  but  hazy  notions  as  to  what  constitutes  the  social  loss  or 
gain.  They  assume  the  corporate  organization  of  industry  as  a 
settled  fact,  without  discriminating  wherein  it  is  really  to  the 
general  advantage.  They  assume  transferability  of  shares  to  be 
a  settled  fact,  without  stopping  to  think  whether  the  gain  from 
quickened  investment  outweighs  the  material  and  moral  loss 
from  gambling.  Still  less  do  they  consider  whether  the  ad- 
vantage from  more  efficient  management  at  the  hands  of  the 
shrewd  outweighs  the  social  disadvantage  arising  from  greater 
inequalities  in  wealth. 

Transferability  often  brings  still  other  unwelcome  conse- 
quences. Control  passes  not  only  to  the  shrewd,  but  to  the 
unscrupulous  also.  The  directors  and  other  "insiders"  who 
are  best  informed  about  the  prospects  of  a  corporation  play  the 
game  with  loaded  dice  when  they  buy  from  the  ordinary  share- 

1  Compare  again  what  is  said  below  in  Book  II,  Chapter  11. 


94  THE  ORGANIZATION  OF  PRODUCTION 

holders  or  sell  to  them.  This  sort  of  action  is  not  indeed  sanc- 
tioned, as  buying  and  selling  among  ordinary  shareholders  is, 
either  by  law  or  by  general  opinion.  In  the  eye  of  the  law,  a 
director  is  in  a  fiduciary  position.  He  is  not  allowed  to  profit 
from  dealings  with  those  whose  interests  he  has  in  charge,  and 
is  under  obligation  to  disgorge  any  gains  from  such  unfaithful 
doings.  In  the  corporation  of  moderate  size,  whose  shares  are 
closely  held,  violation  of  fiduciary  duty  is  frowned  on  by  public 
opinion  also.  But  in  the  great  corporations  the  rigging  of  the 
market  and  speculative  profit  from  inside  information  are  not 
condemned  with  seriousness  in  business  circles ;  and  this 
largely  for  the  reason  that  so  many  play  the  same  game,  or  try 
to  play  it.  The  whole  fry  of  buyers  and  sellers  of  stock  are  try- 
ing to  overreach  each  other.  Those  who  fail  lack  only  the 
shrewdness  or  good  fortune,  not  the  will,  to  get  the  booty. 
In  stock  exchange  gambling,  as  in  dicing  and  card  playing 
and  speculation  in  grain  or  cotton,  it  is  the  presence  of  a  great 
mass  of  greedy  and  gullible  persons  that  creates  the  opportu- 
nities for  the  comparatively  few  who  are  strong  and  shrewd 
as  well  as  unscrupulous. 

It  is  but  just  to  add  that  corporate  management  has  often 
shown  a  high  regard  for  the  duties  of  directors  and  officers,  es- 
pecially in  the  case  of  those  companies  of  moderate  size  in 
which,  as  has  just  been  said,  public  opinion  is  still  strong  in 
condemning  bad  faith.  And  almost  invariably,  even  in  cor- 
porations of  the  most  miscellaneous  ownership,  the  rights  of 
the  shareholder  who  is  duly  registered  on  the  books  are  scru- 
pulously respected.  He  gets  the  benefit  of  every  accruing  profit, 
of  every  windfall,  however  ignorant  or  incompetent  he  be  in  the 
details  of  management.  This  sort  of  regard  for  the  shareholder 
indeed  is  a  sine  qud  non  of  corporate  investment.  It  is  like  the 
good  faith  of  brokers  in  adhering  scrupulously  to  bargains  sig- 
nified only  by  a  nod  of  the  head  or  a  stroke  of  the  pen  on  a 
sale-sheet.  Without  the  certain  maintenance  of  the  mech- 
anism for  carrying  on  the  agreed  operations,  the  whole  fabric 
of  corporate  investment  would  collapse.  It  is  in  the  process 


THE  CORPORATE  ORGANIZATION  OF  INDUSTRY     95 

of  buying  and  selling,  of  becoming  a  shareholder,  that  there 
is  play  for  manipulation.  And  here  again  it  is  sometimes  diffi- 
cult to  draw  a  clear  line  between  the  exercise  of  good  judgment 
and  the  abuse  of  official  position. 

§  4.  Another  consequence  of  the  growth  of  corporations  has 
been  the  increasing  power  of  financial  middlemen.  The  in- 
vestor has  ceased  not  only  to  manage  capital,  but  to  use  care  and 
judgment  of  his  own  as  to  the  use  of  his  savings  in  creating  it. 
The  investment  banks  are  the  most  important  real  directors  of 
the  course  of  investment.  Such  are  the  historic  private  bank- 
ing houses  of  England  and  the  United  States  —  the  Barings, 
the  Rothschilds,  the  Morgans  —  and  the  newly-developed  large 
banking  institutions  of  all  modern  countries,  most  conspicuous 
perhaps  in  Germany.  From  them  "the  public"  buys  its  secu- 
rities, chiefly  the  stocks  and  bonds  of  corporations.  This  pur- 
chase, much  affected  by  the  advice  and  repute  of  the  financing 
bank,  constitutes  for  the  individual  the  act  of  investment. 
What  corporations  shall  be  organized,  what  industries  carried 
on,  what  railways,  mines,  factories  equipped,  is  decided  by  the 
financial  middlemen,  in  consultation  with  the  more  immediately 
active  managers  of  industry. 

Hence  the  great  power  of  those  bankers  who  secure  the  con- 
fidence and  support  of  numbers  of  investors.  It  is  common  to 
speak  of  the  "control"  of  a  given  enterprise  —  a  railway,  a 
factory  or  combination  of  factories,  a  mine  or  complex  of  mines — 
as  being  in  the  hands  of  an  individual  or  a  few  individuals ;  and 
the  public  is  staggered  by  calculations  of  the  hundreds  and 
thousands  of  millions'  worth  of  capital  which  are  dominated  by 
a  Morgan  or  a  Rothschild.  Control  of  this  sort  does  not  signify 
necessarily  or  usually  a  concentrated  ownership  of  those  mil- 
lioas.  It  does  signify  concentrated  power,  based  on  the  con- 
fidence which  a  multitude  of  investors  have  in  the  judgment  and 
leadership  of  commanding  personalities. 

The  concentration  of  control  in  few  hands  shows  itself  most 
strikingly  in  the  United  States.  Though  we  have  been  singularly 
reluctant  to  concentrate  political  control,  we  have  been  un- 


96  THE  ORGANIZATION  OF  PRODUCTION 

hesitating  in  the  acceptance  of  concentrated  industrial  control 
It  is  odd  that  in  England,  where  unification  of  responsibility 
has  been  carried  to  the  maximum  in  public  affairs  (at  least,  in 
the  central  government),  directors  still  direct  in  industry,  and 
the  powers  of  presiding  managers  are  still  strictly  limited.  In 
the  United  States,  where  the  tradition  of  checks  and  balances 
continues  to  shape  political  organization,  directors  in  industrial 
corporations  are  often  no  more  than  figureheads,  while  presidents 
are  benevolent  despots.  This  development  of  one-man  rule  has 
no  doubt  promoted  boldness,  efficiency,  progress;  but  it  has 
also  concentrated  power  in  a  degree  to  justify  uneasiness. 

§  5.  Still  another  consequence  of  the  development  and  refine- 
ment of  corporate  organization  is  an  advance  not  only  in  the 
ease  of  making  investments,  but  in  the  stability  of  the  mere 
investor's  position.  The  ingenuity  of  the  financial  middlemen 
in  vying  for  the  custom  and  support  of  the  great  army  of  savers, 
has  provided  more  and  more  secure  ways  of  investment.  All 
sorts  of  securities  are  offered ;  not  only  those  with  risks  and 
with  a  possibility  of  large  returns,  but  those  with  low  return 
and  absolute  safety.  Government  securities  still  possess  a 
special  prestige  as  to  safety  and  hence  yield  but  the  lowest 
rate  of  interest.  Corporate  securities  are  also  offered  which  are 
hardly  less  safe,  and  enable  the  purchaser  to  dismiss  all  worry 
as  to  the  maintenance  of  principal  and  income.  The  position 
of  the  property  owner,  if  he  is  content  with  a  low  rate  of  return, 
is  highly  secure.  It  used  to  be  said,  and  is  still  occasionally 
repeated,  that  the  maintenance  of  a  fortune  calls  for  as  much 
ability  as  the  making  of  it ;  that  riches  have  wings ;  that  it  is 
but  three  generations  from  shirt  sleeves  to  shirt  sleeves.  This 
is  far  from  being  the  case  in  modern  times.  Chiefly  as  a  result 
of  corporate  organization,  a  sort  of  abstract  or  distilled  property 
has  grown  up,  exempt  from  the  vicissitudes  of  industry.  The 
rich  and  the  well-to-do,  if  they  are  content  with  low  rates  of 
return,  can  make  their  position  almost  impregnable,  and, 
through  inheritance,  can  maintain  it  indefinitely.  A  leisure  class, 
based  not  on  feudal  privilege,  but  on  savings,  investment,  and 
productive  enterprise,  has  become  a  stable  part  of  modern  society. 


CHAPTER  7 
SOME  CAUSES  AFFECTING  PRODUCTIVENESS 

§  1.  The  preceding  chapters  have  dealt  with  such  causes 
affecting  the  productiveness  of  industry  as  the  division  of  labor, 
the  advance  of  large-scale  production,  the  use  and  the  growth  of 
capital.  Some  other  factors  bearing  on  the  efficiency  of  labor  in 
production  will  be  considered  in  the  present  chapter. 

Among  these  other  factors  is  the  quality  of  the  laborers. 
The  increase  of  production  depends  not  only  on  the  marshalling 
and  organization  of  the  laborers  and  on  their  equipment  with 
capital,  but  also  on  the  strength  and  skill  of  the  individual  work- 
men. These  two  factors  —  strength  and  skill  —  may  be  taken 
up  separately. 

There  is  what  may  be  called  the  steam  engine  theory  of  the 
efficiency  of  labor.  It  maintains,  or  perhaps  implies  rather  than 
maintains,  that  the  vigor  of  the  laborer  is  in  proportion  to  what 
he  consumes.  The  more  is  turned  over  to  him,  the  stronger 
will  he  be,  and  the  more  will  he  produce ;  just  as  the  power  got 
from  a  steam  engine  depends  on  the  fuel  burned  in  the  fire  box. 
Feed  your  laborer  better,  and  he  will  be  able  to  do  so  much 
more.  The  proposition  is  an  optimistic  and  comforting  one. 
It  would  indicate  that  higher  wages  will  always  pay  the 
employer. 

There  is  a  measure  of  truth  in  this  view.  It  holds  good  par- 
ticularly of  the  simplest  unskilled  labor,  such  as  calls  for  con- 
tinuous and  heavy  muscular  exertion.  Sometimes  men  are  so 
underfed  that  their  physical  strength  suffers.-  Emplo3rers  of 
large  gangs  of  laborers  find  that  it  pays  to  feed  them  abundantly. 
Military  operations  which  involve  heavy  labor,  and  especially 
those  involving  long  marches,  are  more  likely  to  succeed  if  the 
rank  and  file  get  good  rations.  Millions  of  people  in  backward 
H  97 


98  THE  ORGANIZATION  OF  PRODUCTION 

and  semi-civilized  countries,  such  as  China  and  India,  are  under- 
fed. It  is  probable  that  their  efficiency  could  be  increased  by 
more  food  and  better  housing.  No  small  proportion  of  laborers 
in  civilized  countries  are  in  the  same  situation.  Mr.  Rowntree, 
in  his  investigations  on  the  city  of  York  in  England,  made  an 
estimate  of  the  money  wages  which  would  secure,  at  current 
prices  in  England,  the  food,  shelter,  clothing  needed  for  physical 
efficiency.  The  sum  was  about  20  shillings  a  week  for  a  family 
of  five ;  and  the  earnings  of  one  sixth  of  the  wage-earning  class 
in  York  fall  short  of  that  sum.1  The  case  is  probably  no  less  dis- 
heartening for  many  laborers  in  all  parts  of  Europe ;  and,  not- 
withstanding the  higher  general  range  of  wages  in  the  United 
States,  there  may  be  some  workmen  —  perhaps  but  few  rela- 
tively, yet  in  absolute  numbers  not  insignificant — whose  state 
is  equally  miserable  in  this  country  also. 

It  may  seem  that  where  laborers  are  underfed,  an  increase 
of  wages  up  to  the  point  of  nourishment  adequate  for  full 
physical  efficiency  will  not  be  difficult  to  bring  about,  since 
the  added  product  will  make  the  added  wages  worth  while. 
But  the  case  is  not  so  simple  as  it  appears.  Though  the  laborers 
in  general  may  gain  in  effectiveness  from  more  ample  subsist- 
ence, and  though  the  community  may  become  thereby  a  healthier 
and  happier  social  body,  the  individual  who  makes  the  advances 
to  the  laborers  will  not  necessarily  gain.  If,  indeed,  the  laborers 
were  slaves,  there  would  be  some  chance  of  direct  profit  from 
feeding  them  better.  They  would  remain  the  property  of  the 
master,  and  he  would  reap  where  he  had  sown.  Even  as  regards 
slaves,  to  be  sure,  it  is  not  always  profitable  to  go  to  the  expense 
of  full  feeding.  It  may  be  cheaper  to  work  them  hard  on  poor 
fare,  to  wear  them  out  in  a  few  years,  and  to  buy  new  ones  for 
the  same  wretched  round,  —  a  practise  said  to  have  been  de- 
liberately followed  on  some  Southern  plantations  in  the  slavery 
days.  However  this  may  be,  it  is  obvious  that  the  case  of  free 
men  is  essentially  different..  The  gain  in  effectiveness  from 
better  fare  inures  to  the  laborer  himself.  Any  employer  who 

1  B.  S.  Rowntree,  Poverty:  a  Study  of  Town  Life,  Chapter  IV. 


SOME  CAUSES  AFFECTING  PRODUCTIVENESS          99 

would  make  the  needed  advances  could  have  no  assurance  of 
recouping  himself.  The  effects  of  full  subsistence  on  effective- 
ness do  not  appear  either  with  quickness  or  with  certainty.  The 
process  is  not  quick,  because  time  is  needed  to  bring  weakened 
and  demoralized  laborers  into  good  condition.  It  is  not  certain, 
because  some  among  them  are  so  enfeebled  by  sustained  hard- 
ship, or  congenitally  so  weak  in  constitution,  that  they  will 
never  become  able-bodied.  Even  though  a  body  of  underfed 
laborers,  if  in  hand  systematically,  could  be  brought  to  a  pitch 
of  full  vigor,  the  risks  and  uncertainties,  as  well  as  the  prob- 
ability that  the  regenerated  men  would  betake  themselves  to 
employment  elsewhere,  make  it  hopeless  for  a  profit-seeking 
employer  to  carry  out  any  operation  of  the  kind.  It  is  only 
under  exceptional  circumstances,  where  large  gangs  of  selected 
men  are  at  work  in  out-of-the-way  places  and  are  therefore 
under  a  quasi-compulsion  to  stick  to  their  job  —  say  in  build- 
ing the  Panama  Canal  or  at  construction  camps  in  remote 
regions,  —  that  it  is  to  the  immediate  interest  of  the  employer 
to  supply  the  means  for  ample  support. 

The  class  of  underfed  laborers,  comparatively  small  though  it 
be  in  modern  communities,  presents  a  distressing  problem. 
They  are  ill  paid  because  they  are  inefficient;  they  are  ineffi- 
cient, for  one  reason,  because  they  are  ill  paid.  Yet  they  are 
easily  demoralized;  too  often  they  remain  still  inefficient  if 
better  paid  from  charitable  funds.  Neither  physically  nor 
morally  do  they  respond  readily  to  possibilities  of  improvement. 
Often  the  adults  are  hopeless ;  the  children  alone  can  be  taken 
in  hand  with  prospects  of  success.  Hence  even  when  there  is 
a  prima  fade  case  for  increasing  the  productiveness  of  labor 
by  adding  to  the  reward  of  labor,  the  precise  method  of  ac- 
complishing the  result  is  hard  to  devise.  Only  public  or 
quasi-public  action  can  grapple  with  the  problem;  and  this 
must  include  suppression  or  elimination  of  the  unfit,  as  well  as 
uplifting  of  the  potentially  capable. 

All  this  reasoning  and  speculation,  however,  is  concerned 
only  with  the  minimum  necessary  for  health  and  strength: 


100  THE  ORGANIZATION  OF  PRODUCTION 

the  minimum  for  health  and  strength,  be  it  noted,  not  foi 
keeping  body  and  soul  together.  Men  can  live  and  do  work 
for  less  than  is  necessary  to  enable  them  to  do  full  work.  The 
minimum  for  efficiency  is  above  the  starvation  level.  But 
when  they  once  get  what  is  necessary  for  complete  physical 
vigor,  anything  in  addition  is  mere  surplus;  surplus,  that  is, 
in  that  it  no  further  increases  efficiency.  If  obtained,  it  must 
be  as  the  consequence  of  skill  and  productiveness ;  it  becomes 
a  result  of  high  efficiency,  and  ceases  to  be  a  cause  of  efficiency. 
Nor  is  the  minimum  for  full  vigor  a  very  high  one.  An  abundant 
vegetable  diet,  rude  shelter,  and  simple  clothing  are  all  that  a 
man  needs  to  do  the  hardest  work  which  the  human  frame  can 
stand.  The  frugal  Italian  or  the  rice-fed  Chinaman,  if  only 
he  gets  enough  of  his  simple  fare,  can  do  as  much  as  the  meat- 
eating  Irish- American. 

In  some  of  the  higher  walks  of  life,  the  minimum  for  effi- 
ciency is  doubtless  to  be  measured  more  liberally.  Something 
more  is  called  for  than  that  which  is  indispensable  for  muscular 
efficiency.  The  work  of  a  lawyer,  physician,  teacher,  business- 
man, calls  for  alertness  of  mind  and  bodily  health  more  than 
for  physical  vigor.  The  requisite  response  of  intelligence  will 
often  be  lacking  if  the  surroundings  dull  the  mind  or  enfeeble 
the  spirit.  Hence  as  regards  intellectual  work  we  may  count 
among  the  necessaries  for  efficiency,  varied  food,  ample  lodging, 
restful  relaxation.  It  is  hard  to  say  just  how  far  such  sources 
of  enjoyment,  procured  by  a  larger  income,  are  really  necessary 
for  the  best  exertion  of  the  mental  faculties.  Those  who  are 
accustomed  to  comfortable  living  and  to  pleasant  distractions 
easily  convince  themselves  that  these  are  necessary  to  keep  them 
fresh  for  their  work.  It  is  a  sort  of  excuse,  too,  or  justifica- 
tion, of  the  existing  inequalities  in  income  to  believe  that  they 
are  inevitable,  in  the  sense  that  the  work  which  earns  the 
higher  income  could  not  be  accomplished  without  the  freer  life 
which  that  higher  income  secures.  Yet  plain  living  and  high 
thinking  are  not  incompatible.  The  luxuries  and  comforts  to 
which  most  persons  of  the  well-to-do  classes  are  habituated  could 


SOME  CAUSES  AFFECTING  PRODUCTIVENESS        101 

be  in  large  measure  foregone  without  loss  of  vigor  or  freshness. 
Some  comfort,  some  leisure,  some  distraction,  are  doubtless 
necessary  for  the  best  intellectual  work.  But  a  modest  income 
and  a  scale  of  expenditure  much  below  that  of  most  members 
of  the  well-to-do  class  would  suffice. 

§  2.  Different  from  strength  are  skill  and  intelligence. 
These  tell  strongly  on  the  efficiency  of  the  individual  workman 
and  on  the  productivity  of  industry  at  large. 

Many  of  the  improvements  in  the  arts  depend  for  their 
application  on  a  good  degree  of  intelligence.  The  Hottentot 
cannot  use  tools  even  of  a  comparatively  simple  kind  because 
his  brain  power  is  not  sufficiently  developed.  Negroes  are 
employed  in  great  numbers  in  the  gold  mines  and  diamond 
mines  of  South  Africa,  but  for  simple  pick  and  shovel  work 
only.  For  handling  and  guiding  machines  skilled  and  intelli- 
gent white  mechanics  must  be  employed.  Many  of  the  opera- 
tions of  agriculture  require  nothing  beyond  delving  and  ditch- 
ing. But  the  fruitful  agriculture  of  advanced  peoples  calls  for 
care,  discrimination,  intelligence,  and  could  not  be  practised 
by  Indian  ryots  or  Russian  peasants.  Many  routine  opera- 
tions of  modern  industry  can  be  carried  on  by  any  persons 
capable  of  giving  steady  attention.  But  that  very  faculty, 
like  the  ability  and  willingness  to  do  prolonged  continuous 
labor,  is  not  a  matter  of  course.  It  is  not  possessed  by  savages ; 
it  is  a  slowly  acquired  quality  of  civilized  man.  No  doubt 
there  is  a  growing  range  of  machine  work  in  which  very  slender 
intellectual  or  moral  qualities  are  needed.  In  many  factory 
operations  of  modern  times,  the  human  worker  is  hardly  more 
than  another  steady  and  dependable  automaton.  Along  with 
labor  of  this  sort,  however,  there  must  always  go  some  propor- 
tion of  labor  more  flexible,  more  observing,  more  highly 
trained.  This  is  the  quality  of  mechanics'  work,  as  distinguished 
from  that  of  "laborers' "  in  the  narrower  sense.  Here  accuracy, 
watchfulness,  skill,  intelligence,  are  called  for;  and  here  these 
qualities  are  indispensable  for  efficiency. 

The  effect  of  education  on  the  productiveness  of  labor  is  not 


102  THE  ORGANIZATION  OF  PRODUCTION 

simple.  In  some  respects,  a  wide  diffusion  of  education  ifc 
conducive  to  greater  efficiency  of  the  population  at  large;  in 
other  respects,  the  extension  of  education  raises  economic 
questions  not  so  easy  to  answer. 

The  simplest  kind  of  pick  and  shovel  work  seems  to  be  done 
as  effectively  by  the  illiterate  workman  as  by  the  educated. 
This  is  also  the  case,  as  has  just  been  remarked,  with  much 
modern  factory  labor.  And  even  in  many  handicrafts,  edu- 
cation is  not  indispensable  for  a  high  degree  of  skill.  The 
work  of  the  craftsmen  of  the  Middle  Ages  in  Europe,  and  that 
of  the  same  class  of  workers  in  modern  Japan  and  indeed  in 
some  parts  of  contemporary  Europe,  show  that  illiteracy  is  no 
obstacle  to  the  deftest  use  of  tools. 

Nevertheless,  it  remains  true  that  a  wide  diffusion  of  educa- 
tion is  a  most  effective  means  toward  productiveness.  It  is 
effective  particularly  toward  propagating  new  kinds  of  effi- 
ciency. When  an  art  has  once  been  learned  by  slow  steps,  — 
for  thus,  historically,  mankind  has  acquired  most  of  the  arts,  — 
its  mere  transmission  from  generation  to  generation,  its  main- 
tenance and  even  perfection,  take  place  by  the  simplest  imita- 
tion, unaided  by  book  learning.  But  the  rapid  spread  and 
utilization  of  improvements  are  immensely  promoted  by  the 
ease  of  intellectual  communication.  Mere  ability  to  read  and 
write  opens  at  once  a  whole  new  world.  He  who  possesses  it 
can  learn  from  the  experience  of  all  mankind,  no  longer  from 
that  of  his  parents  and  masters  only.  The  extension  of  such 
a  great  improvement  as  the  system  of  interchangeable  parts 
has  depended  largely  on  widespread  elementary  education. 
A  complex  tool  or  machine  —  a  plow,  a  reaper,  a  bicycle  —  is 
made  nowadays  on  standardized  patterns,  each  part  being  a 
precise  duplicate  of  every  other  part  made  from  the  same 
pattern.  When  there  is  a  break,  the  needed  part  can  be  re- 
placed at  once.  The  system  makes  possible  the  wide  use  of 
intricate  apparatus  in  localities  distant  from  repair  shops. 
But  its  adoption  is  possible,  in  turn,  only  if  those  who  are  to 
use  the  apparatus  have  some  general  intelligence  and  if  they 


SOME  CAUSES  AFFECTING  PRODUCTIVENESS        103 

can  read  instructions.  In  the  United  States  the  unexampled 
use  of  labor-saving  agricultural  implements,  all  made  with 
interchangeable  parts,  has  rested  not  only  on  the  intelligence 
of  the  people,  but  on  the  universal  diffusion  of  elementary 
education.  The  great  industrial  advance  of  Germany  during 
the  last  generation  is  due  in  large  measure  to  the  same  factors. 

Technical  education  obviously  has  a  direct  economic  effect. 
The  training  of  civil  engineers,  mechanical  engineers,  electrical 
engineers,  conserves  from  generation  to  generation  the  elabo- 
rate acquired  arts.  It  promotes,  too,  the  advance  of  the  arts. 
In  the  past,  great  inventions  and  improvements  have  probably 
come  as  often  from  the  workshop  as  from  the  laboratory. 
Under  the  conditions  of  the  modern  world,  and  especially  with 
the  more  methodical  application  of  natural  science  to  the  arts, 
the  laboratory  is  likely  to  play  a  larger  and  larger  part,  both 
directly,  through  the  inventions  that  come  full-fledged  from 
the  laboratory,  and  indirectly,  through  the  work  of  those  who 
have  had  its  training. 

All  training  for  the  arts  and  professions  tends  to  become 
more  systematic  in  the  modern  world.  The  engineer  gets  his 
fundamental  training,  not  in  the  workshop  or  in  the  field,  but 
in  the  technological  school ;  the  physician  or  the  lawyer  gets 
his,  not  from  the  active  practitioner,  but  from  the  professional 
school.  The  same  movement  is  seen  in  the  extension  of  in- 
dustrial training  to  the  familiar  mechanic  arts.  Apprenticeship 
to  a  craftsman  was  for  centuries  the  mode  in  which  these  arts 
were  maintained  and  transmitted.  But  the  conditions  of 
modern  industry  have  made  apprenticeship  ineffective  and 
virtually  obsolete.  The  "master"  of  former  times  has  well- 
nigh  disappeared;  he  is  replaced  by  the  large  employer,  out 
of  touch  with  his  individual  workmen,  whether  young  or  old. 
Those  preliminary  stages  of  industrial  training  which  were  hi 
former  times  provided  by  apprenticeship  should  now  be  un- 
dertaken by  systematic  trade  schools,  and  should  be  a  part 
of  the  general  system  of  public  education.  The  time  is  not 
distant  when  the  normal  entrance  to  a  trade  will  be  through 


104  THE  ORGANIZATION  OF  PRODUCTION 

such  schools,  precisely  as  the  normal  entrance  to  the  so-called 
liberal  professions  is  through  their  professional  schools. 

We  must  distinguish  sharply  between  the  effect  of  such 
education  on  individuals  and  on  the  community.  As  between 
individuals,  the  wide  diffusion  of  educational  opportunities 
has  simply  an  equalizing  effect.  For  the  community,  it  tends 
to  raise  general  efficiency;  but  it  is  not  likely  to  raise  general 
efficiency  in  the  same  degree  as  it  raises  the  earnings  of  some 
individuals.  It  tends  to  break  down  any  privileged  position 
which  may  exist  among  those  who  now  possess  technical  or 
professional  skill.  It  may  tend  to  lower  their  earnings.  On 
the  other  hand  it  tends  to  raise  the  earnings  of  those  who  are 
enabled  more  easily  to  acquire  such  skill.  The  trade  unions  are 
usually  opposed  to  the  establishment  of  trade  schools,  from  a 
fear  that  it  will  lower  the  rate  of  wages  in  the  more  highly-paid 
trades.  This  fear,  though  much  exaggerated,is  not  entirely  without 
foundation.  People  who  descant  on  the  advantages  of  educa- 
tion, and  especially  of  industrial  education,  often  contrast  the 
high  wages  of  a  skilled  workman  or  trained  engineer  with  the 
low  wages  of  an  unskilled  laborer,  and  assume  the  difference 
to  measure  the  relative  productiveness  of  the  two.  They 
forget  that  if  all  men  could  easily  procure  the  training 
for  the  better  paid  occupation,  numbers  in  that  occupation 
would  be  greater,  and  pay  in  it  would  be  less.  Wide  and  free 
diffusion  of  all  sorts  of  vocational  training  would  almost  cer- 
tainly increase  the  productive  power  of  the  community  as  a 
whole ;  but  it  would  also  tend  to  lessen  the  differences  in  earn- 
ings which  now  exist,  and  to  lower  the  earnings  of  some  indi- 
viduals and  some  classes  now  favored.1 

General  education  in  all  its  grades,  from  that  of  the  ele- 
mentary school  to  that  of  the  university,  though  not  directed  to  a 
clearly  defined  industrial  end,  doubtless  has  its  considerable 
economic  effects.  Largely  it  is  an  end  in  itself,  or  at  least  a 
means  to  other  ends  than  industrial  efficiency.  The  mere 
attainment  of  knowledge  and  understanding  is  a  satisfaction 

1  On  this  subject  more  is  said  below,  in  Book  V,  Chapter  47. 


SOME  CAUSES  AFFECTING  PRODUCTIVENESS        105 

in  itself,  to  some  persons  a  great  joy.  Among  man's  traits  none 
is  more  remarkable  than  his  insatiable  curiosity  concerning  all 
things  in  the  heavens  and  the  earth.  The  satisfaction  of  that 
curiosity  is  one  of  the  constant  ends  of  human  endeavor.  And 
knowledge  opens  the  way,  it  need  not  be  said,  to  the  higher 
and  nobler  enjoyment  of  life.  But  general  education  has  its 
more  immediate  economic  effects  also.  Though  reading  and  writ- 
ing do  not  make  the  ditch  digger  stronger,  and  geometry  and 
literature  do  not  add  directly  to  the  skill  of  the  mechanic,  all 
education  makes  for  intelligence,  discrimination,  the  utilization 
of  opportunities,  the  spread  of  improvements.  It  makes  also 
for  sobriety,  honesty,  and  steady  endeavor.  The  more  it  is 
directed  to  uplifting  the  character  and  training  the  faculties, 
and  the  less  it  follows  dull  routine,  the  more  does  it  achieve 
these  ends.  Where  it  fails  to  achieve  them,  the  remedy,  even 
in  the  interest  of  bare  industrial  efficiency,  is  still  not  to  curtail 
it,  but  to  improve  it. 

§  3.  Not  least  effective  among  the  forces  that  bear  on  pro- 
ductiveness is  leadership.  It  is  exercised  by  business  managers, 
by  engineers  and  technical  experts,  and  by  men  of  science. 
Economic  efficiency  is  profoundly  affected  by  the  success  of  a 
community  in  securing  good  leaders. 

When  intricate  tools  and  machinery  are  put  together  by 
skilled  mechanics,  and  when  all  this  apparatus  is  guided  to  its 
productive  outcome  by  still  other  skilled  mechanics,  one  is 
tempted  to  say  that  here  are  the  real  producers.  But  a  little 
consideration  leads  to  the  inclusion  with  them  of  the  designers, — 
the  inventors  and  engineers.  It  requires  still  further  reflection 
to  include  also  the  directors  and  employers.  These  last,  the 
business  class,  seem  to  some  persons,  notably  to  the  socialists, 
to  be  mere  exploiters.  The  real  work  seems  to  be  done  by  the 
others ;  the  business  men  sit  by  and  merely  levy  toll.  There 
is  no  greater  misapprehension.  The  effectiveness  of  industry 
depends  on  the  business  man's  leadership  almost  as  much  as  that 
of  an  army  depends  on  generalship.  Under  a  complicated  divi- 
sion of  labor,  the  various  factors  of  production  must  be  brought 


106  THE  ORGANIZATION  OF  PRODUCTION 

together  and  properly  combined.  The  different  kinds  of  labor 
and  capital  must  be  applied  to  the  best  natural  resources.  The 
long  gap  between  producer  and  consumer  must  be  bridged.  The 
skilled  mechanic  and  even  the  engineer  would  commonly  be 
helpless  without  the  guidance  of  the  business  leader.  Especially 
is  this  the  case  where  industry  is  rapidly  shifting.  Courage, 
energy,  judgment,  and  command  of  capital  are  indispensable 
for  economic  progress.  Much  more  will  be  said,  as  we  proceed, 
on  the  significance  of  industrial  leadership. 

Another  kind  of  leadership  is  that  of  the  man  of  science.  The 
progress  of  material  civilization  depends  on  the  understanding 
of  nature's  laws.  The  astronomer,  the  physicist,  the  chemist, 
the  biologist  lay  the  foundation  for  the  development  of  the  arts. 
Their  efforts  are  usually  stimulated  in  greater  degree  than  with 
most  men  by  motives  of  the  higher  sort, — by  the  single-minded 
search  for  truth,  or  by  love  of  fame  rather  than  hope  of 
material  reward.  The  influence  of  scientific  investigation  on  the 
arts,  though  often  indirect  and  unexpected,  is  none  the  less  far- 
reaching.  Faraday  had  no  concern  for  the  industrial  possibilities 
when  he  discovered  the  induced  current;  yet  how  profoundly 
economic  progress  has  been  affected  by  the  dynamo  ! 1 

Leaders  are  rare.  Most  men  are  commonplace.  Among  the 
means  for  promoting  progress  none  are  more  important  than 
the  discovery  and  stimulation  of  those  who  have  high  abilities. 

Freedom  of  opportunity  and  diffusion  of  education  are  the 
means  for  discovering  those  possessing  unusual  gifts.  Among 
the  classes  of  men  who  now  lack  education  and  are  depressed  by 
illiterate  surroundings,  there  may  be  many  persons  of  talent  and 
an  occasional  genius.  To  the  general  advantage  of  a  wide  diffu- 
sion of  education  is  to  be  added  the  fact  that  it  helps  to  arouse 
and  develop  all  the  gifted.  It  is  probable,  to  be  sure,  that  high 
inborn  capacity  is  most  common  among  those  to  whom  education 

1  My  colleague,  Professor  C.  L.  Jackson,  has  called  my  attention  to  Perkin's 
discovery  of  purple  dye,  which  led  to  the  aniline  dye  industry,  and  to  th« 
investigations  of  Graebe  and  Liebermann  on  alizarin,  which  led  to  the  manu- 
facture of  that  coloring  stuff  from  coal  tar;  further  instances  of  industrial 
changes  consequent  on  the  discoveries  of  pure  science. 


SOME  CAUSES  AFFECTING  PRODUCTIVENESS        107 

and  opportunity  are  already  open.  We  touch  here  on  the 
debatable  problem  of  the  origin  and  significance  of  social 
classes.  There  is  evidence  tending  to  show  that  the  well-to-do 
are  in  their  more  favored  position  because  they  possess,  on  the 
whole,  higher  intellectual  ability.  But  the  proposition,  even  if 
established,  is  subject  to  much  qualification ;  and  certainly  it 
must  be  admitted  that  there  is  among  the  less  prosperous  some 
fund  of  capacity  which  fails  to  be  utilized.  Though  gifted 
persons  are  probably  less  common,  in  proportion  to  numbers, 
among  the  so-called  lower  classes,  there  may  be  many  of  them. 
The  full  development  in  these  of  all  their  qualities  for  better 
efficiency,  above  all  for  leadership,  is  one  of  the  most  important 
objects  of  widely  diffused  education. 

Freedom  and  democracy  operate  to  develop  to  the  full  the 
scanty  number  of  leaders.  The  abolition  of  class  privileges  in 
modern  times  thus  has  been  not  only  of  political  and  social  con- 
sequence, but  has  had  direct  economic  effects  also.  The  in- 
dustrial preeminence  of  England  during  the  eighteenth  and  nine- 
teenth centuries  was  due  largely  to  her  free  institutions.  The 
lowborn  person's  opportunities  to  rise,  even  though  restricted, 
were  better  than  on  the  Continent,  and  England  profited  accord- 
ingly. In  the  United  States  such  opportunities  have  been  more 
free  than  ever  before  in  any  part  of  the  world,  and  to  this 
factor,  above  all  others,  is  due  the  wonderful  material  prosperity 
of  the  country. 

Those  possessed  of  the  qualities  for  leadership  must  not 
only  be  given  a  free  field ;  they  must  also  be  stimulated  to  the 
full  exercise  of  their  gifts.  Inequality  of  some  sort  appears 
to  be  indispensable  as  a  stimulus. 

Obviously  we  have  here  a  question  different  from  those  con- 
sidered in  the  preceding  pages.  There  is- an  essential  difference 
between  providing  a  gifted  person  with  the  wherewithal  to  en- 
able him  to  do  his  best  and  offering  him  a  reward  which  will 
stimulate  him  to  do  his  best.  A  reward  in  some  way  propor- 
tioned to  the  rarity  and  effectiveness  of  unusual  faculties  seems 
necessary  to  induce  their  exertion  to  the  highest  pitch.  Such, 


108  THE  ORGANIZATION  OF  PRODUCTION 

at  all  events,  has  been  the  experience  of  mankind  with  the  gift 
of  industrial  leadership.  No  stimulus  to  economic  activity 
has  yet  been  found  comparable  in  efficacy  to  that  of  the 
prospect  of  large  earnings.  Inequality  of  incomes  and  posses- 
sions, so  far  as  based  on  differences  in  industrial  efficiency,  is 
a  most  potent  instrument  toward  general  efficiency  in  pro- 
duction. 

This,  to  be  sure,  is  the  individualist  view.  It  assumes  that 
most  men  are  influenced  in  their  bargaining  and  income-earning 
by  preponderantly  selfish  motives.  The  extreme  collectivist 
view  is  that  men  can  be  readily  induced  to  the  full  application 
of  their  faculties  by  other  than  selfish  motives.  Neither  view  can 
be  maintained  without  qualification.  Some  sorts  of  leadership 
are  undertaken  with  little  consideration  of  reward.  Those 
having  the  very  highest  intellectual  gifts  in  letters,  in  the  fine 
arts,  in  pure  science,  exercise  them  in  pursuance  of  a  well- 
nigh  irresistible  impulse.  On  the  other  hand,  industrial  leader- 
ship and  industrial  efficiency  seem  to  depend  on  industrial 
reward.  Whether  there  are  possibilities  of  stimulating  them 
without  inequality,  or  at  all  events  without  great  inequality, 
is  a  question  reaching  into  the  most  difficult  problems  of  eco- 
nomics, and  its  full  consideration  must  be  postponed  to  a  later 
stage.1  Suffice  it  to  say  that  material  reward,  in  the  shape  of 
high  income  and  the  chance  of  a  fortune,  has  hitherto  proved 
wonderfully  potent  and  apparently  indispensable  in  eliciting  and 
spurring  economic  leadership. 

§  4.  In  sum,  the  effectiveness  of  industry  depends  not  only  on 
material  equipment,  but  also  on  what  we  may  call  immaterial 
equipment ;  not  only  on  accumulated  surplus  in  the  way  of 
capital,  but  on  accumulated  moral  and  intellectual  qualities. 
Maintenance  and  transmittal  are  not  less  important  for  this 
immaterial  capital  than  for  the  community's  material  capital. 

Education  transmits  from  generation  to  generation  the 
acquired  attainments  of  the  race,  from  the  rudiments  of  reading 
and  writing  to  the  most  elaborate  technical  training.  Not  only 
>  See  Book  VII,  Chapter  65. 


SOME  CAUSES  AFFECTING  PRODUCTIVENESS        109 

these  intellectual  attainments,  but  moral  qualities  likewise, 
must  be  handed  down  to  the  successive  generations.  Habits 
of  industry,  truthfulness,  honesty,  sobriety,  of  consideration  for 
others,  of  care  for  the  common  good,  —  all  these  are  of  slow 
growth,  and  rest  on  repeated  example  and  precept. 

In  some  degree  there  is  transmission  also  by  inheritance. 
The  biologists  still  differ  on  the  question  whether  acquired 
traits  are  inherited.  The  more  general  opinion  seems  to  be 
that  they  are  not,  and  that  only  inborn  qualities  are  passed  on 
from  parent  to  descendant.  If  this  be  the  rule  universal  in 
nature,  man  also  must  conform  to  it ;  and  then  some  at  least  of 
the  qualities  that  mark  the  civilized  man  can  be  maintained  only 
by  set  training.  Others  perhaps  have  been  incorporated  in  his 
nature  by  a  process  of  selection,  —  through  the  weeding  out,  in 
the  long  course  of  history,  of  those  having  a  less  civilizable  dis- 
position. Human  nature  changes  and  improves,  and  the  quality 
of  men  is  now  finer  than  it  was  thousands  of  years  ago,  perhaps 
than  it  was  centuries  ago.  Repeatedly  there  are  projects  for 
hastening  the  process  through  design,  —  by  breeding  men,  as 
animals  are  bred,  from  strains  deliberately  selected.  Without 
entering  here  on  the  far-reaching  questions  which  such  proposals 
raise,  it  may  be  said  that,  for  a  future  as  far  as  we  can  look  into 
it,  the  slow  and  haphazard  process  of  unconscious  selection  will 
alone  affect  the  transmission  and  possible  improvement  of  inborn 
qualities.  As  regards  the  general  average  of  ability  and  charac- 
ter, heredity  leaves  man,  from  one  generation  to  another,  on 
the  whole  in  statu  quo. 

But  persistent  and  repeated  training  not  only  keeps  man- 
kind in  statu  quo:  it  offers  more  immediate  possibilities  of 
advance.  No  less  than  inherited  quality,  it  contributes  to  make 
the  difference  between  the  civilized  man  and  the  savage.  Man's 
great  moral,  intellectual,  educational  capital  must  be  conserved, 
like  his  material  capital,  by  unremitting  effort ;  and  like  that  it 
can  be  increased  by  effort.  In  both  ways,  the  effort  is  largely 
altruistic.  It  results  from  the  cares  and  sacrifices  of  parents, 
and  from  the  conscious  endeavor  of  the  community  to  improve 


110  THE  ORGANISATION  OF  PRODUCTION 

the  quality  of  all  its  members  through  the  diffusion  of  education. 
But  it  results  also  in  no  small  degree  from  the  self-regarding 
motives,  —  from  the  desire  of  each  individual  to  better  his  own 
condition  and  that  of  his  family.  Certain  it  is  that  man  now 
starts  from  a  vantage  ground  which  makes  possible  still  further 
advance.  Some  of  his  qualities  for  civilization  he  has  inherited ; 
some  of  those  same  qualities  he  acquires  and  transmits  by  con- 
stant effort.  The  outcome  of  all  is  the  great  immaterial  capital 
of  the  community  ;  a  possession  not  less  important  for  the  gen- 
eral welfare,  and  perhaps  not  less  extensible,  than  his  capital  of 
tools  and  materials. 


REFERENCES  ON  BOOK  I 

On  productive  and  unproductive  labor,  see  the  often-cited  passages 
in  Adam  Smith,  Wealth  of  Nations,  Book  II,  Chapter  III ;  and  those  in 
J.  S.  Mill,  Principles  of  Political  Economy,  Book  I,  Chapter  III.  W. 
Roscher,  Political  Economy,  Book  I,  Chapter  III,  gives  an  excellent  his- 
torical and  critical  account.  Among  modern  discussions,  none  is  more  de- 
serving of  attention  than  the  paper  by  Professor  T.  Veblen,  on  "indus- 
trial" and  "pecuniary"  employments,  in  Proceedings  of  the  American 
Economic  Association,  1901,  No.  1.  A  recent  discussion,  with  not  a 
little  of  clouded  thought,  is  in  the  Verhandlungen  des  Vereins  fur 
Sozialpolitik,  1909 ;  especially  a  paper  by  Professor  E.  Philippovich 
and  the  discussion  thereon. 

On  the  division  of  labor,  Charles  Babbage,  On  the  Economy  of  Ma- 
chinery and  Manufactures  (1837),  is  still  to  be  consulted.  On  modern 
developments,  the  Thirteenth  Annual  Report  of  the  Commissioner  of 
Labor  (U.  S.)  on  Hand  and  Machine  Labor  (1899)  contains  a  multi- 
tude of  illustrations.  A  keen  analysis  of  the  division  of  labor  in  its 
historical  forms  is  in  K.  Biicher,  Die  Entstehung  der  Volkswirthschaft 
(7th  ed.,  1910) ;  translated  into  English  from  the  3d  German  edition 
under  the  title  Industrial  Evolution  (1901).  On  the  industrial  revolu- 
tion of  the  eighteenth  century,  see  the  well-ordered  narrative  in  Man- 
toux,  La  revolution  indvstrielle  au  xviii*  siecle  (1906),  and  the  less 
systematic  but  more  philosophical  account  in  A.  Toynbee,  Lectures  on 
the  Industrial  Revolution  (10th  ed.,  1894). 

On  capital,  see  the  references  given  below,  at  the  close  of  Book  V. 
Much  as  has  been  written  of  late  on  corporate  doings  and  corporate 
organization,  I  know  of  no  helpful  references  on  the  topics  considered 
in  Chapter  6. 


BOOK  II 
VALUE  AND  EXCHANGE 


CHAPTER  8 
INTRODUCTORY  :   EXCHANGE,  VALUE,  PRICE 

§  1.  The  division  of  labor  brings  in  its  train  the  exchange  of 
goods  between  those  who  undertake  the  separated  acts  of  pro- 
duction. Exchange  in  turn  brings  the  phenomena  of  value, 
money,  and  prices.  With  these  phenomena  we  shall  be  con- 
cerned in  the  present  Book  and  in  the  Book  following. 

As  has  already  been  noted,  the  division  of  labor  does  not  bring 
exchange  as  a  necessary  consequence.1  There  may  be  the  self- 
sufficing  patriarchal  family,  with  division  of  labor  but  without 
exchange;  or  its  counterpart,  the  communistic  society,  self- 
sufficing  at  least  in  some  degree.  Even  in  the  modern  family, 
there  is  division  of  labor,  after  a  sort,  between  man  and  wife. 
But  commonly  we  consider  the  family  as  a  unit,  and  think  of 
the  housewife,  when  she  works  for  husband  and  family,  as  work- 
ing for  that  of  which  she  is  but  a  part.  Similarly,  the  patriarchal 
family  and  the  communistic  society  are  considered  by  their  mem- 
bers as  economic  units.  Exchange  arises  from  a  separation  of 
interests.  As  between  individuals,  it  has  grown  with  the  growth 
of  private  property.  Throughout  by  far  the  greater  part  of 
modern  industry,  division  of  labor  prevails,  and  with  it  private 
property  and  labor  for  one's  self  and  family.  Hence  exchange 
and  its  concomitants,  value  and  price. 

Production  for  one's  self  holds  its  own  longest  in  agriculture. 
Yet  even  in  this  industry,  division  of  labor  and  exchange  are 
rapidly  extending  in  the  highly  developed  countries  of  our  time. 
In  the  United  States  the  self-sufficing  farmer  of  earlier  days  has 
well-nigh  disappeared;  and  even  the  stolid  peasant  of  Europe 
is  being  transformed  by  the  modern  methods  of  easy  communica- 
tion and  easy  exchange.  Though  the  farmer  still  produces  part  of 

1  See  Book  I,  Chapter  3,  §  4. 
I  113 


114  VALUE  AND  EXCHANGE 

his  own  food,  especially  vegetables  and  fruit,  there  is  a  steady 
tendency  toward  widening  the  range  of  agricultural  products 
which  are  bought  and  sold.  Grain  is  sold  by  the  individual 
farmer,  flour  is  bought ;  cattle  are  sold,  meat  is  bought ;  milk 
and  cream  are  sold,  butter  is  bought.  In  other  occupations  than 
agriculture  the  division  of  labor  has  worked  out  its  consequences 
to  the  last  stage.  No  labor  is  given  to  the  direct  satisfaction  of 
each  worker's  wants  by  himself;  all  is  turned  to  the  indirect 
process  of  specialization  and  exchange.  Hence  sale,  price,  value, 
and  the  whole  mechanism  of  exchange,  become  the  characteris- 
tic economic  phenomena. 

§  2.  Almost  as  early  as  the  division  of  labor,  a  medium  for 
exchanging  the  various  products  came  into  use.  Barter  —  the 
direct  exchange  of  products  —  may  be  carried  on  under  a  very 
simple  division  of  labor;  yet  even  then  it  is  inconvenient,  and 
as  soon  as  the  first  stages  of  savagery  have  been  passed,  some 
use  of  a  medium  of  exchange  appears. 

Any  commodity  in  general  use  will  serve  passably  as  a  medium 
of  exchange.  He  who  has  an  article  to  sell,  and  cannot  find  at 
once  the  precise  kind  and  quantity  of  the  things  he  wishes  to  buy, 
will  accept  a  staple  commodity,  with  which  sooner  or  later  he 
will  be  able  to  procure  the  things  he  wants.  Hence  in  various 
stages  of  civilization,  the  most  diverse  commodities  have  been 
used  to  obviate  the  inconveniences  of  barter.  In  Homeric 
times  the  value  of  things  was  often  stated  in  terms  of  oxen ;  for 
such  occasional  exchanges  as  are  made  among  primitive  pastoral 
peoples  are  naturally  effected  in  terms  of  their  staple  commodity, 
cattle.1  For  a  considerable  time  in  the  early  history  of  the 
colony  of  Virginia,  tobacco  was  almost  the  sole  article  of  export, 
and  the  chief  commodity  habitually  produced  for  a  market ;  it 
became  the  recognized  medium  of  exchange  in  the  colony.  Furs, 

1  Mr.  Wicksteed  remarks  (The  Common  Sense  of  Political  Economy,  p.  137) 
that  "there  is  more  evidence  in  the  Homeric  poems  of  the  valuation  of  female 
slaves,  of  tripods,  or  of  gold  or  brass  armor,  in  terms  of  so  many  cattle,  than 
there  is  of  any  direct  transfer  of  cattle  in  payment  of  those  goods."  It  is  prob- 
ably true,  also,  of  the  other  commodities  mentioned  in  the  text  that  they  were 
used  more  freely  for  measuring  relative  values  than  for  effecting  exchanges. 


INTRODUCTORY:  EXCHANGE,   VALUE,   PRICE         115 

salt,  tea,  cocoa,  have  served  the  purpose  with  other  people. 
But  by  far  the  most  widespread  among  the  things  so  used  have 
been  the  precious  metals,  gold  and  silver.  We  need  not  pause 
at  this  stage  to  consider  what  qualities  fit  them  peculiarly  for 
serving  as  a  medium  of  exchange,  —  their  luster  and  consequent 
attractiveness  for  ornament,  their  freedom  from  rust  and 
deterioration,  their  homogeneity,  their  divisibility.  Nor  need 
we  consider  how  the  device  of  coining  has  increased  their  fitness 
for  carrying  on  purchases  and  sales;  nor  in  what  ways  paper 
representatives  or  substitutes  for  them  have  come  to  be  so 
widely  used  in  our  own  time.  These  are  topics  that  belong  to 
the  subject  of  money,  to  which  much  attention  must  be  given 
later. 

It  suffices  here  to  note  how  completely  division  of  labor  and 
exchange  work  out  their  results  through  the  use  of  money. 
Every  producer  gets  his  return  in  amounts  of  money.  The 
exceptions  in  any  of  the  countries  of  advanced  civilization  are 
so  few  and  are  so  rapidly  disappearing  that  they  serve  only 
to  make  clear  how  virtually  universal  is  the  rule.  Exchange 
takes  place  by  first  selling  goods  or  services  for  money,  and 
by  then  buying  with  the  money  such  other  goods  and  services 
as  are  wanted.  The  fundamental  fact  of  exchange  is  thus  ob- 
scured by  the  very  mechanism  that  so  perfectly  facilitates  it. 
Just  as  the  cooperation  and  combination  which  are  essential 
features  of  the  division  of  labor  are  carried  on  without  a  con- 
sciousness of  any  combined  action,  so  the  process  of  exchange 
goes  on  without  the  consciousness  that  it  is  the  aim  and  end  of 
all  buying  and  selling. 

§  3.  The  value  of  a  commodity  means  in  economics  its 
power  of  commanding  other  commodities  in  exchange.  It  means 
the  rate  at  which  the  commodity  exchanges  for  others.  If  a 
bushel  of  wheat  can  be  exchanged  for  a  large  quantity  of  other 
things,  —  for  many  pounds  of  iron,  many  yards  of  cloth,  many 
ounces  of  salt,  —  its  value  is  high ;  the  possessor  of  it  can  procure 
many  of  these  things.  If  a  bushel  of  wheat  can  be  exchanged 
for  but  few  pounds  of  iron,  few  yards  of  cloth,  few  ounces  of 


116  VALUE  AND  EXCHANGE 

salt,  its  value  is  low;  the  possessor  of  it  can  procure  few  of 
these  things.  It  is  immaterial  that  the  exchange  does  not  take 
place  directly,  but  by  the  process  of  first  disposing  of  the  wheat 
for  the  medium  of  exchange,  —  money,  —  and  then  pro- 
curing with  the  money  the  iron,  cloth,  salt,  or  other  desired 
commodities.  The  result  of  the  double  operation  is  the  same 
as  if  the  exchange  had  taken  place  by  direct  barter.  Only  it  is 
reached  by  a  more  convenient  method. 

The  value  of  a  commodity,  thus  conceived,  is  its  value  in 
exchange.  This  is  very  different  from  its  usefulness,  or  utility, 
or  importance.  In  everyday  discourse,  we  use  the  word  "  value  " 
sometimes  to  indicate  exchange  value,  sometimes  to  indicate 
utility  or  importance.  We  speak  of  the  value  of  iron  as  greater 
than  that  of  gold,  and  the  value  of  wheat  as  greater  than  that 
of  diamonds.  We  mean  thereby  that  iron  and  wheat  are  more 
important,  satisfy  more  urgent  wants  than  gold  and  diamonds. 
Yet  we  also  speak  of  gold  and  diamonds  as  more  valuable 
commodities  than  iron  and  wheat;  then  we  use  the  terms 
"  value  "  and  "  valuable  "  in  the  sense  of  value  in  exchange, 
and  mean  that  exchange  and  sale  take  place  on  such  terms 
that  with  comparatively  little  gold  and  diamonds  the  owner 
can  secure  much  iron  and  wheat.  For  the  purposes  of 
economics  this  latter  sense,  exchange  value,  is  the  most  impor- 
tant. 

A  third  sense,  however,  may  be  noted  in  passing.  People 
sometimes  speak  of  the  "value"  of  a  thing  as  greater  or  less 
than  that  which  appears  in  an  actual  transaction  of  exchange. 
They  speak  of  a  house  as  being  "worth"  more  than  they  paid 
for  it,  or  of  a  commodity  or  a  stock  exchange  security  as  selling 
for  less  than  its  "intrinsic  value."  They  mean  that  the  cur- 
rent price  is  different  from  the  price  that  is  likely  to  be  paid  in 
the  long  run,  or  different  from  the  price  which  they  think 
proper  and  just.  In  the  sense  which  we  have  adopted,  value 
means  simply  the  actual  rate  in  exchange,  and  there  can  be  no 
value  other  than  that  registered  by  sales  and  exchanges.  That 
the  word  is  also  used  with  this  third  signification,  of  proper 


INTRODUCTORY:   EXCHANGE,   VALUE,   PRICE        117 

or  intrinsic  worth,  only  shows  how  vague  and  uncertain  is 
everyday  phraseology.  Economists  have  often  pointed  out 
how  much  troubled  they  are,  both  in  exposition  and  in  their 
own  thinking,  by  having  to  employ  familiar  terms,  like 
capital  and  value,  which  in  everyday  use  have  various  and 
shifting  meanings.  For  the  purposes  of  economics,  one  mean- 
ing or  definition  must  be  selected,  and  held  to  with  care.  In 
the  following  pages  "value"  will  be  used  strictly  in  the  sense 
which  economists  have  adopted  for  it,  —  a  relation  in  exchange. 

By  the  price  of  a  commodity  is  signified  the  amount  of 
money  which  it  will  command;  in  other  words,  its  value  in 
terms  of  the  accepted  medium  of  exchange.  The  notion  of 
price  is  familiar,  whereas  that  of  value  is  one  to  which  the 
beginner  in  economics  must  become  accustomed.  In  modern 
times  price  means,  in  almost  all  advanced  countries,  the  amount 
which  is  got,  in  exchange,  of  the  particular  money  medium 
which  these  countries  have  adopted,  —  gold.  Paper  and 
metallic  substitutes  for  gold  are  often  used,  equal  in  exchange 
value  to  the  gold,  and  performing  the  functions  of  a  medium 
of  exchange  precisely  as  it  does.  The  peculiarities  of  paper, 
silver,  and  copper  as  money  will  receive  attention  in  due  time. 
For  the  present  we  shall  assume  that  gold  is  the  medium  of 
exchange,  and  that  price  is  measured  in  coins  of  gold,  say 
dollars.  Coins,  it  needs  hardly  to  be  added,  are  simply  pieces 
of  gold  manufactured  with  care  and  containing  each  a  given 
weight  of  metal  of  uniform  quality. 

§  4.  From  the  definition  of  value,  it  follows  that  there  can 
be  no  general  rise  in  values,  and  no  general  fail  in  values. 
Value  is  a  term  expressing  the  relation  of  exchange  between 
commodities.  If  at  a  given  time  a  commodity  procures  in 
exchange  less  of  others  than  at  an  earlier  time,  it  has  fallen  in 
value;  but  pro  tanto  those  other  commodities  have  risen  in 
value.  All  cannot  rise  and  fall  together.  A  change  in  the 
value  of  any  one  of  them,  or  any  set  of  them,  means  a  converse 
change  in  the  value  of  the  rest.  On  the  other  hand,  a  change 
in  general  prices  is  not  only  possible,  but  is  one  of  the  familiar 


118  VALUE  AND  EXCHANGE 

and  recurring  phenomena  of  economics.  Wheat,  iron,  diamonds, 
things  in  general,  may  all  exchange  for  more  dollars  now  than 
they  did  ten  years  ago;  and  ten  years  hence  they  may  ex- 
change for  less  dollars  than  they  command  now. 

Evidently  a  general  rise  or  fall  in  prices  signifies  a  change 
in  the  value  of  money,  that  is,  of  gold.  When  all  prices  rise, 
and  things  exchange  each  for  a  greater  number  of  dollars,  the 
dollar  can  buy  less  than  it  did.  Its  power  of  commanding  other 
things  is  less,  and  its  value  has  fallen.  When  every  single 
thing  exchanges  for  a  smaller  number  of  dollars ;  that  is,  when 
prices  have  fallen,  the  dollar  buys  more,  and  its  value  has  risen. 
The  value  of  money  is  inverse  to  the  level  of  prices.  When 
prices  are  high,  the  value  of  money  is  low.  When  prices  are 
low,  the  value  of  money  is  high. 

The  mere  fact  of  a  rise  or  fall  in  the  price  of  a  single  com- 
modity, therefore,  does  not  indicate  whether  or  no  its  value 
has  changed.  It  may  be  that  this  single  commodity  alone  has 
fallen  in  price,  others  remaining  as  before.  In  that  case  the 
fall  in  price  registers  also  a  fall  in  value.  Or  it  may  be  that 
other  commodities  likewise  have  fallen  in  price  to  the  same 
extent.  In  that  case  there  has  been  a  rise  in  the  value  of 
money,  and  a  fall  in  the  value  of  all  commodities  as  compared 
with  gold;  but  no  change  has  occurred  in  the  values  of  com- 
modities inter  se. 

The  value  of  gold,  that  is,  the  general  level  of  prices,  changes 
but  slowly.  Though  prices  of  individual  commodities  change 
quickly,  all  do  not  change  quickly  in  the  same  direction.  A 
rise  in  the  price  of  any  one  is  likely  to  be  accompanied  by  a 
declining  price  of  another,  or  by  stationary  prices  of  the  others. 
So  gradual  are  changes  in  the  general  range  of  prices,  so  uncer- 
tain the  comparison  and  offsetting  of  the  complex  individual 
changes,  —  a  rise  here,  a  fall  there,  no  change  at  all  in  a  third, 
—  that  it  is  often  difficult  to  ascertain  for  a  short  period  whether 
a  general  change  has  really  taken  place.  If,  indeed,  an  upward 
or  downward  movement  continues  for  years,  it  usually  becomes 
unmistakable.  We  can  ascertain  then  whether  the  value  of 


INTRODUCTORY:   EXCHANGE,   VALUE,   PRICE        119 

money  has  risen  or  fallen,  and  can  measure  with  some  accuracy 
the  extent  of  the  change.  But  unless  the  lapse  of  time 
exceed  two  or  three  years,  it  is  often  not  easy  to  determine 
what  has  been  the  general  trend ;  so  stable  are  prices  for  short 
periods. 

But  though  general  prices  and  the  value  of  money  change  thus 
slowly,  the  prices  of  individual  articles  change  quickly  and 
considerably.  The  price  of  wool  or  cotton  or  iron  may  rise 
by  ten  per  cent  in  the  course  of  a  month;  and  changes  are 
common  in  the  prices  of  individual  articles  —  of  wheat,  cotton, 
copper,  coal  —  by  ten,  twenty,  thirty,  per  cent  in  the  course 
of  a  single  year.  Where  the  price  of  one  thing  changes,  other 
prices  remaining  the  same,  the  new  price  evidently  registers  a 
change  in  value.  The  ordinary  fluctuations  in  the  prices  of 
things  hence  signify  corresponding  changes  in  their  values. 

For  the  purposes  of  an  orderly  and  systematic  exposition  of 
economic  principles,  we  shall  assume  for  the  present  stability 
in  general  prices ;  hence  that  a  change  in  the  price  of  an  article 
signifies  a  change  in  its  value.  If  an  individual  article  rises 
in  price  under  these  conditions,  it  commands  more  of  other 
things  in  exchange,  and  rises  in  value;  and  conversely  if  it 
falls  in  price.  We  shall  thus  use  the  familiar  examples  of  price 
and  money  in  our  illustrations  and  figures,  and  shall  put  aside, 
for  consideration  at  a  later  stage,  the  problems  of  fluctuations 
in  the  general  level  of  prices. 


CHAPTER  9 

VALUE  AND  UTILITY 

§  1.  An  object  can  have  no  value  unless  it  has  utility.  No 
one  will  give  anything  for  an  article  unless  it  yield  him  satis- 
faction. Doubtless  people  are  sometimes  foolish,  and  buy 
things,  as  children  do,  to  please  a  moment's  fancy;  but  at 
least  they  think  at  the  moment  that  there  is  a  wish  to  be 
gratified.  Doubtless,  too,  people  often  buy  things  which,  though 
yielding  pleasure  for  the  moment,  or  postponing  pain,  are  in 
the  end  harmful.  But  here,  as  has  already  been  explained,  we 
must  accept  the  consumer  as  the  final  judge.  The  fact  that 
he  is  willing  to  give  up  something  in  order  to  procure  an  article 
proves  once  for  all  that  for  him  it  has  utility,  —  it  fills  a  want. 

On  the  other  hand,  no  less  evidently,  the  value  of  an  object 
is  not  in  proportion  to  its  utility.  Free  goods,  such  as  fresh 
air,  pure  water,  the  beauty  of  nature,  may  have  high  utility, 
though  wholly  without  value.  Only  slight  value  may  attach  to 
other  things  having  high  utility.  In  our  advanced  civilized 
communities  the  simplest  and  most  wholesome  articles  of  food 
have  low  value ;  they  are  cheap.  Yet  they  satisfy  the  most 
elemental  and  pressing  of  wants,  and  have  great  utility.  So 
it  is  of  other  necessaries  of  life,  as  clothing,  shelter,  or  warmth  ; 
great  utility  often  goes  with  low  value.  On  the  other  hand, 
some  things  whose  exchange  value  is  high  have  utilities  which 
we  do  not  ordinarily  reckon  great.  Jewels,  tasteless  ornaments, 
a  stupid  book  printed  four  hundred  years  ago,  —  such  things 
sometimes  command  a  high  price,  though  the  satisfactions  they 
yield  are  not  of  a  high  order  or  apparently  highly  prized. 

§  2.  The  supply  of  a  commodity,  as  we  all  know,  closely 
affects  its  value.  When  an  article  becomes  abundant,  its  price 
falls ;  when  it  is  scarce,  its  price  rises.  The  causes  of  these 

120 


VALUE  AND  UTILITY  121 

fluctuations  are  two,  very  different  in  nature  and  social  sig- 
nificance. 

One  obvious  cause,  and  that  which  many  persons  are  likely 
to  think  of  first,  is  the  difference  in  means  between  rich  and 
poor.  Those  who  are  able  to  pay  highest,  secure  the  first  in- 
stallments of  any  commodity  that  comes  to  market.  If  there 
be  comparatively  few  installments,  each  will  command  a  high 
price.  As  more  and  more  are  offered,  the  price  must  be  lowered 
in  order  to  bring  them  within  the  means  of  the  less  rich.  Finally, 
if  the  supply  be  greatly  increased,  the  price  must  be  lowered 
very  much  in  order  to  make  possible  purchases  by  the  poor. 

But  the  same  result  would  appear  if  there  were  no  differ- 
erences  between  rich  and  poor,  —  if  all  persons  had  the  same 
incomes.  Then,  also,  an  increasing  supply  would  bring  a  de- 
creasing price.  The  causes  which  under  these  altered  condi- 
tions would  yet  lead  to  the  same  inverse  variation  are  of  the 
second  sort;  and  they  are  the  fundamental  causes. 

Consider  any  familiar  article  of  daily  use,  —  the  knives, 
forks,  spoons,  on  your  table,  the  clothing  you  wear,  the  house 
you  live  in.  One  set  of  knives  and  forks  is  essential  to  cleanly 
eating.  A  second  set  is  highly  convenient,  a  third  somewhat 
less  so ;  there  is  a  decline  in  utility,  until  at  last  the  stage  is 
reached  where  an  additional  set  is  a  mere  encumbrance.  So 
with  clothing.  One  suit  is  necessary.  A  second  and  a  third 
add  to  comfort.  More  and  more  can  be  used,  yet  with  a 
steady  tendency  to  lessening  satisfaction  with  the  successive 
installments.  One  room  in  a  house,  or  a  one-room  house,  is 
indispensable  for  existence.  The  added  comfort  and  decency 
from  a  second  room  are  very  great ;  and  further  additions  to 
houseroom  continue  to  yield  satisfactions.  But  though  the  rate 
of  diminution  in  utility  may  be  for  some  time  comparatively  slow, 
the  tendency  still  is  present,  and  before  long  the  stage  is  reached, 
when  more  houseroom  serves  to  satisfy  only  the  love  of  dis- 
play, not  to  yield  substantial  comfort.  All  things,  it  may  be 
observed,  which  minister  to  the  love  of  display,  have  the  pos- 
sibility of  maintaining  this  sort  of  utility  in  a  curious  degree. 


122  VALUE  AND  EXCHANGE 

The  mere  fact  that  a  thing  is  rare  —  that  it  is  of  a  sort  not 
possessed  by  others,  and  so  distinguishes  its  owner  —  gives 
utility  to  things  otherwise  useless;  a  notable  example  is  an 
old  postage  stamp.1  Additions  to  the  supply  of  many  classes 
of  articles  may  for  a  long  time  give  additional  satisfaction, 
if  the  individual  things  be  varied  and  adapted  to  gratify  the 
love  of  distinction;  as  with  the  garments  and  houses  of  the 
rich.  But  the  tendency  to  diminishing  utility  none  the  less 
persists.  The  more  of  these  things  you  have,  the  less  you 
prize  any  one.  The  addition  of  a  new  coat  to  an  abundant 
supply,  of  a  new  room  to  a  house  already  large,  brings  less 
satisfaction  than  the  preceding  coats  or  rooms  brought. 

To  this  general  tendency  we  give  the  name  of  the  principle, 
or  law,  of  diminishing  utility.  Successive  doses  of  the  same 
commodity  or  service  yield  diminishing  utilities.  If  the  doses 
be  continued  indefinitely,  the  point  of  satiety  will  be  reached. 
Then  further  doses  yield  no  satisfaction  whatever ;  the  utility 
of  each  additional  dose  becomes  nil.  This  principle,  as  has  just 
been  intimated,  and  as  will  presently  be  explained  further,  ap- 
plies in  strictness  only  to  doses  of  the  same  commodity  (or 
service).  Vary  the  thing  supplied,  —  even  though  different  only 
in  small  degree,  —  then  the  result  will  not  be  quite  the  same. 
The  diminution  in  utility  may  be  prevented  or  checked ;  and 
the  point  of  satiety  may  be  indefinitely  postponed.  From  the 
fact  that  there  is  a  limit  to  the  possibilities  of  satisfaction  from 
increasing  the  supply  of  any  one  article,  it  is  not  to  be  inferred 
that  limits  in  utility  exist  for  all  articles  taken  together. 

But  none  the  less  it  remains  true  that  all  enjoyments  tend  to 
pall  if  repeated.  If  any  one  of  us  were  called  on  to  retrench,  — 
to  dispense  with  some  enjoyments  now  possessed,  —  he  would 
find  himself  cutting  off  first  those  things  least  prized,  and  then 
in  succession  various  others  in  the  inverse  order  of  their  utility ; 
a  process  which  would  make  it  clear  not  only  that  some  things 

1  No  doubt  the  instinct  of  acquisition  (the  "collecting"  instinct)  plays  its 
part  as  regards  such  articles,  in  combination  with  the  instinct  for  distinction 
through  display. 


VALUE  AND  UTILITY  123 

have  more  utility  than  others,  but  that  some  doses  of  the  same 
thing  have  more  utility  than  other  doses  of  that  thing. 

It  is  this  fact  of  different  and  diminishing  utility  that  explains 
the  growing  variety  in  the  articles  produced  and  the  growing 
complexity  of  production  and  consumption.  As  the  productive 
power  of  mankind  increases,  and  especially  as  the  commodities 
in  common  use  become  more  abundant,  labor  is  constantly 
turned  in  new  directions.  It  is  given  not  so  much  to  making 
more  of  the  same  things  as  to  making  different  things. 
Abundance  without  variety  means  that  the  approach  to  satiety 
is  rapid.  Bread,  in  most  civilized  countries,  is  cheap,  being 
produced  with  comparatively  little  labor.  With  increase  in  the 
effectiveness  of  industry,  more  and  more  bread  could  be  pro- 
duced with  the  same  labor.  But  some  of  this  labor  turns  to 
other  kinds  of  food  as  bread  becomes  cheaper,  —  to  meat,  eggs, 
butter,  vegetables,  fruit,  sugar.  A  varied  diet,  such  as  is  pos- 
sible in  modern  times,  marks  a  great  advance  not  only  over  the 
monotony  of  savages'  food,  but  over  the  very  restricted  diet  with 
which  civilized  peoples  had  to  content  themselves  until  the  last 
century  or  two.  The  essentials  of  clothing,  also,  are  plentiful 
and  cheap,  and  a  comparatively  small  part  of  the  labor  of  a 
modern  country  is  given  to  the  covering  needed  simply  for 
health  and  decency.  A  vast  deal  of  labor  is  given  to  making 
more  convenient  and  attractive  clothing.  With  the  growing 
productiveness  of  labor,  any  one  of  the  familiar  articles  of  every- 
day use  tends  to  be  put  on  the  market  in  such  quantities  that 
people  care  less  and  less  for  additional  increments,  and  the 
prices  of  these  articles  are  ever  tending  to  fall.  Variety  in  pro- 
duction must  take  place  if  consumption  is  to  respond. 

There  are  articles  to  which  the  principle  of  diminishing  utility 
does  not  apply  as  unfailingly  as  the  preceding  statement  sug- 
gests. Though  stimulants  on  the  whole  show  unquestionably  the 
tendency  to  lessening  response,  the  conscious  effect  from  the 
first  few  doses  does  not  always  show  it.  The  second  or  third 
glass  of  liquor  may  be  as  much  enjoyed  as  the  first.  Or,  to 
speak  of  higher  things,  the  second  or  third  reading  of  noble 


124  VALUE  AND  EXCHANGE 

verse,  or  hearing  of  beautiful  music,  often  gives  greater  pleasure 
than  the  first.  Again,  there  are  many  cases  where  a  preliminary 
stage  of  doubtful  satisfaction  is  succeeded,  with  habituation,  by 
unquestionably  greater  satisfaction ;  as  with  tobacco  and  oysters. 
Many  a  novel  article  needs  to  be  insinuated  into  people's  liking. 
As  this  is  brought  about  (perhaps  by  skillful  advertising),  the 
article  reaches  a  stage  where  a  larger  supply  of  it  is  sold,  not  at  a 
lower  price  per  unit,  but  at  a  higher.  In  such  cases,  however, 
the  tastes  of  the  purchasers  may  be  said  to  have  changed  in  the 
interval.  At  any  given  stage  of  taste  and  popularity,  the 
principle  of  diminishing  utility  will  apply.  It  is  not  worth 
while  to  enter  on  refinements  as  to  whether,  in  the  cases  just 
mentioned,  there  are  real  or  only  apparent  exceptions  to  the 
principle.  The  qualifications  that  may  be  needed  are  of  no 
great  importance.  The  tendency  shows  itself  so  widely  and 
with  so  few  exceptions  that  there  is  no  significant  inaccuracy 
in  speaking  of  it  as  universal. 

§  3.  From  the  law  of  diminishing  utility  we  are  led  to  the 
conceptions  of  total  utility  and  of  marginal  utility. 

Utility  can  be  measured,  for  the  purposes  of  economic  study, 
in  one  way  only :  by  the  amount  which  a  person  will  give  to  pro- 
cure an  article  or  a  service.  Enjoyment  or  satisfaction  is  sub- 
jective. The  objective  test  of  it  is  willingness  to  pay.  What  a 
person  will  pay  for  an  article  rather  than  go  without  it,  is  the 
only  test  by  which  we  can  ascertain  with  any  approach  to  pre- 
cision how  much  satisfaction  it  brings  him.  Hence  price,  actual 
or  potential,  is  the  economic  measure  of  utility.  Not  infre- 
quently in  discussion  of  this  set  of  subjects,  it  is  said  or  implied 
that  the  utility  of  an  article  is  the  price  it  commands  or  might 
command.  This  language  is  inaccurate.  Price  simply  indicates 
utility. 

Consider  now  how  price  may  measure  the  utility,  to  an  in- 
dividual, of  several  units  of  a  given  commodity,  —  say  five 
oranges.  Suppose  them  to  be  offered  in  succession,  each  being 
appraised  by  itself  without  thought  of  there  being  more  to  come. 
The  first  we  may  believe  to  be  so  fragrant  and  refreshing  that  the 


VALUE  AND  UTILITY  125 

individual  would  pay  50  cents  rather  than  go  without  it.  The 
second,  yielding  less  satisfaction,  would  command  only  25  cents ; 
the  third  would  command  still  less,  say  15  cents ;  the  fourth,  10 ; 
and  the  fifth  only  5.  The  total  utility  of  the  five  would  be  in- 
dicated by  the  sum  of  the  amounts  which  the  several  units  would 
have  commanded  separately,  namely :  — 

For  the  first  orange 50  cents 

For  the  second  orange 25  cents 

For  the  third  orange 15  cents 

For  the  fourth  orange 10  cents 

For  the  fifth  orange 5  cents 

For  the  total  supply 105  cents 

Suppose  now,  on  the  other  hand,  that  the  five  oranges  exist 
as  a  stock,  possessed  together  by  the  individual.  All  are  alike. 
Take  away  any  one,  and  the  loss  of  utility  or  satisfaction  will  be 
the  same  as  if  any  other  had  been  taken  away.  Each  has  the 
same  degree  of  importance  for  his  welfare.  As  installments  or 
successive  doses,  they  have  differing  utility.  But  possessed  as 
a  stock,  they  have  each  the  same  economic  importance.  Any 
one  would  be  parted  with  on  the  same  terms  as  another.  And 
those  terms  —  the  price  —  would  be  settled  by  the  utility 
(satisfaction)  yielded  by  the  last  of  them  if  they  were  enjoyed  in 
succession.  The  price  at  which  the  fifth  would  be  bought  (or 
sold)  is  the  price  at  which  any  one  of  a  stock  of  five  would  be 
bought  (or  sold).  That  price  measures  the  marginal  utility,  or 
final  utility,  of  the  supply.  Economic  importance;  marginal 
utility ;  final  utility ;  the  satisfaction  got  from  any  one  unit  of  a 
stock,  —  all  these  expressions  come  to  the  same  thing. 

It  may  seem  paradoxical  to  say  that  all  the  constituents  of  a 
stock  have  the  same  economic  importance,  and  that  none  the 
less  some  have  greater  utility  than  others.  But  there  is  no  real 
paradox.  It  must  be  remembered  that  utility  means  satisfac- 
tions or  enjoyments.  To  possess  a  stock  is  not  to  enjoy  it  (except 
so  far  as,  by  association  of  ideas,  mere  ownership  gives  pleasure  ; 
as  in  case  of  a  miser's  hoard).  The  stock  is  necessarily  enjoyed, 
not  as  a  whole,  but  by  installments ;  and  as  it  comes  to  be  so 


126  VALUE  AND  EXCHANGE 

enjoyed,  the  successive  installments  yield  lessening  satisfaction. 
Economic  importance  is  something  different ;  it  is  the  satisfac- 
tion dependent,  not  on  the  whole  stock,  but  on  any  one  of  the 
constituents  of  the  stock.  Considered  in  this  way,  all  the  con- 
stituents are  alike ;  even  though,  considered  as  sources  of  enjoy- 
ment when  actually  used,  they  are  of  varying  utility. 

§  4.  Let  us  return  now  to  the  relation  between  the  supply  of 
an  article  and  its  price.  Increase  in  supply  means  lower  price. 
It  also  means  lessening  utility  from  the  added  units.  The  price 
of  a  commodity  depends,  as  the  case  is  commonly  stated,  on 
the  least  of  the  utilities  yielded  by  the  supply,  or  on  final 
utility.  Price,  or  value,  depends  on  the  utility  of  the  last 
increment.  Properly  qualified,  and  properly  understood,  the 
principle  is  sound;  and  not  only  so,  but  of  primary  impor- 
tance. 

First  as  to  the  qualifications.  The  proposition  is  true,  in 
strictness,  only  if  we  suppose  many  competing  buyers  and 
sellers.  And  in  fact  most  things  are  brought  to  market  by  com- 
peting sellers,  and  are  purchased  by  competing  buyers.  Assume 
now  that  a  given  supply,  say  1000  oranges,  is  offered  by  the  sel- 
lers. Among  the  buyers  are  some  whose  means  are  large,  others 
who  value  oranges  highly.  Both  sets  would  be  willing  to  pay 
a  high  price  for  a  few  oranges  rather  than  go  without.  But 
there  are  more  oranges  than  these  purchasers  are  eager  for.  To 
induce  the  rest  to  buy,  or  to  induce  the  eager  purchasers  to  buy 
more,  the  price  must  be  lowered.  As  the  sellers  are  many  and 
competing,  the  price  of  the  whole  supply  will  be  uniform.  Any 
one  seller,  trying  to  obtain  a  higher  price  from  the  eager  buyers, 
would  be  undersold  by  others.  There  would  be  one  price  at 
which  the  whole  lot  would  go,  and  that  would  be  the  price 
which  tempted  the  last  buyer ;  or,  to  be  more  accurate,  the  last 
purchase  by  any  of  the  buyers.  This  last  purchase,  and  the 
price  which  must  be  offered  to  induce  it,  would  settle  the 
terms  for  all  the  transactions. 

Next,  as  to  the  just  understanding  of  the  proposition.  Ob- 
serve that  the  last  buyer  and  the  last  purchase  have  been  spoken 


VALUE  AND  UTILITY  127 

of,  not  the  last  or  marginal  utility.  In  the  usual  statements  of 
this  fundamental  principle  of  value,  it  is  said  simply  that  selling 
price,  or  exchange  value,  depends  on  marginal  utility.  The  as- 
sumption is  here  tacitly  made  that  all  the  buyers  are  in  the  same 
position  and  that  all  have  the  same  means.  From  this  it  would 
follow  that  a  less  sum  of  money  paid  out  denoted  a  less  utility, 
and  that  he  who  bought  the  last  unit  of  the  whole  supply  was 
not  only  the  last  purchaser,  but  the  purchaser  to  whom  that  unit 
gave  the  least  satisfaction.  The  fact  is,  however,  that  pur- 
chasers have  very  different  means,  and,  as  just  pointed  out,  this 
circumstance  is  of  vast  importance  in  explaining  the  fall  in  price 
which  actually  takes  place  when  supply  is  increased.  The  de- 
pendence of  selling  price  on  the  last  purchaser  (or  the  last 
purchase)  is  not  affected  by  the  inequality  of  incomes.  But  the 
significance  of  the  final  purchase  for  the  utility  or  satisfaction- 
yielding  power  of  the  last  installment  of  the  supply  is  much 
affected. 

The  simple  and  familiar  fact  that  a  rich  man,  when  paying  out 
a  given  sum  of  money,  often  gets  less  satisfaction  than  a  poor 
man  when  he  pays  out  the  same  sum,  is  expressed  in  more  techni- 
cal terms  by  saying  that  the  marginal  utility  of  money  is  less 
to  the  rich  than  to  the  poor.  A  dollar  signifies  little  to  the  man 
of  means.  If  he  parts  with  it,  his  loss  in  welfare  is  vastly  less 
than  that  of  the  poor  man  who  parts  with  the  same  amount. 
A  high  price  therefore  does  not  necessarily  indicate  great 
utility  to  those  paying  it.  It  may  signify  only  that  the  mar- 
ginal utility  of  money  is  small. 

The  phrase  "marginal  utility  of  money"  must,  however,  be 
used  with  caution.  Money  has  utility  in  a  different  way  from 
other  things.  It  is  valued  not  because  it  serves  in  itself  to 
satisfy  wants,  but  as  a  medium  of  exchange,  having  purchasing 
power  over  other  things.  Gold  jewelry  is  subject  to  the  law  of 
diminishing  utility  precisely  as  other  things  are.  But  gold  coin 
—  money  —  is  subject  to  it  only  in  the  sense  that  an  individual 
buys  first  the  things  he  prizes  most,  and  then  other  things  in  the 
order  of  their  less  utility.  Strictly  speaking,  the  statement  that 


128 


VALUE  AND  EXCHANGE 


money  has  varying  utility  and  that  there  is  a  marginal  utility  ot 
money  is  only  a  way  of  saying  that  the  things  bought  with  money 
have  varying  utility,  and  that  some  among  them  are  at  the  mar- 
gin of  utility.1 

§  5.  The  conceptions  of  total  utility  and  marginal  utility  lead 
to  that  of  consumer's  surplus. 

Consumer's  surplus  is  the  phrase  applied  by  Professor  Mar- 
shall (who  has  done  more  than  any  other  writer  to  make 
clear  this  whole  subject)  to  the  difference  between  the  sum 
which  measures  total  utility  and  that  which  measures  total 
exchange  value.  The  total  exchange  value  of  a  set  of  goods 
is  obviously  the  price  per  unit  (determined  by  marginal 
utility)  multiplied  by  the  number  of  units.  But  the  total 
utility  of  the  units  as  they  come  to  be  enjoyed  is  a  different 
quantity.  Thus,  our  orange-eater  would  have  been  willing  to 
pay  for  the  first  orange  50  cents,  but  had  to  pay  only  5  cents. 
He  had  a  "surplus"  of  45  cents'  worth  of  satisfaction.  Using 
the  same  figures  as  before  for  the  supposed  supply  of  five 
oranges,  we  get  the  following  comparison  between  the  prices 
that  would  have  been  paid  and  the  prices  that  were  paid  in  fact ; 
the  difference  indicating  consumer's  surplus. 


POTENTIAL  PRICE, 
MEASURING  TO- 

ACTUAL PRICE 

CONSUMER'S 
SURPLUS 

TAL  UTILITY 

For  the  first  orange  .... 

50 

5 

45 

For  the  second  orange  . 

25 

5 

20 

For  the  third  orange  .  .  . 

15 

5 

10 

For  the  fourth  orange  .  . 

10 

5 

5 

For  the  fifth  orange  .... 

5 

5 

For  the  whole  supply  .  . 

105 

25 

80 

The  case  is  stated  here  in  the  simplest  terms,  and  on  the  assump- 
tion that  the  price  of  this  small  supply  of  oranges  would  be 
determined  as  the  price  of  the  usual  large  supply  of  commodi- 
ties as  they  come  to  market  in  the  actual  world,  —  by  marginal 
utility,  or  at  a  price  which  carries  off  the  last  increment.  With- 

1  See  what  is  said  further  on  this  topic,  and  on  the  peculiarities  of  the  value 
of  money,  in  Book  III,  Chapter  18. 


VALUE  AND  UTILITY  129 

out  stopping  now  to  inquire  how  far  this  assumption  in  fact  holds 
good  where  a  very  few  commodities  are  put  on  sale,1  let  us  con- 
sider the  nature  of  consumer's  surplus,  as  here  typified. 

How  substantial  is  this  surplus  ?  and  how  far  is  this  mode  of 
measuring  it  satisfactory  ?  To  ask  these  questions  is  only  to  ask, 
in  different  words,  how  substantial  total  utility  is,  and  how  far 
we  can  measure  total  utility. 

One  limitation  of  the  first  importance  has  already  been  in- 
dicated when  considering  marginal  utility  and  its  connection 
with  demand.  If  all  persons  had  the  same  income,  then  will- 
ingness to  pay  a  given  amount  for  an  article  might  be  fairly 
assumed  to  mean  that  the  article  had  the  same  utility  for  each 
of  them.  But  some  have  greater  incomes  than  others;  the 
marginal  utility  of  money  is  less  to  the  rich;  and  the  pay- 
ment by  them  of  a  larger  sum  does  not  signify  a  higher  utility. 
A  rich  man  will  pay  for  hothouse  fruits  or  vegetables  a  sum 
quite  out  of  the  question  for  a  person  of  modest  means.  The 
latter  may  secure,  at  a  season  of  greater  plenty,  precisely  the 
same  things  for  a  price  much  lower.  The  rich  man  probably 
gets  no  greater  enjoyment  from  his  expensive  purchase ;  or,  if 
so  (counting  as  part  of  his  pleasure  the  gratification  of  the 
love  of  distinction),  by  no  means  in  proportion  to  the  higher 
price  he  pays.  If  some  of  the  familiar  comforts  of  civilized 
life  become  scarce, — fresh  milk  or  good  bread, — they  would 
command  a  high  price,  even  if  all  persons  had  the  same  incomes. 
But  the  price  would  go  still  higher  if  there  were  a  circle  of  per- 
sons able  and  ready  to  bid  heavily  for  them  without  making 
serious  gaps  in  their  incomes.  The  special  increase  of  price 
resulting  from  this  latter  circumstance  is  indicative,  not  of 
specially  high  utility,  but  of  large  means  for  purchasing  utilities. 

Still  another  qualification  is  suggested  by  the  fact  of  in- 
equality. Many  articles  which  command  a  high  price  satisfy 
the  passion  for  display.  Such  are  the  precious  stones,  rare 
paintings,  and  statues.  No  doubt  many  things  of  this  sort  — 
the  great  works  of  art  —  are  intrinsically  beautiful,  and  yield 

1  See  the  next  chapter  in  this  book,  Chapter  10,  §  9. 

X 


130  VALUE  AND  EXCHANGE 

enduring  and  unalloyed  pleasures;  and  it  is  their  intrinsic 
beauty,  tested  by  time,  that  is  at  the  basis  of  their  high  value. 
Being  not  only  beautiful,  but  also  rare,  they  satisfy  in  addition 
the  deep-rooted  instinct  of  emulation  and  desire  for  distinction. 
They  have  what  has  been  called  a  prestige  value.  They  com- 
mand a  higher  price  simply  because  they  are  already  high  in 
price.  Suppose  now  that  such  things  become  common  and 
therefore  cheap;  that  diamonds,  for  example,  become  very 
plentiful,  and  that  their  price  falls  to  some  such  level  as  that 
of  glass  beads.  The  intrinsic  qualities  of  diamonds  would 
remain ;  their  luster  and  brilliancy,  their  hardness.  The  satis- 
faction which  the  previous  limited  supply  had  given  might  be 
thought,  therefore,  to  remain  undiminished.  Yet  in  fact  it 
would  be  vastly  diminished ;  for  diamonds  would  no  longer  be 
evidences  of  wealth  and  social  station.  Consumer's  surplus, 
as  measured  by  the  previous  high  price,  would  evaporate. 

Consumer's  surplus  is  thus  unsubstantial  for  a  considerable 
range  of  articles  now  much  esteemed  and  paid  for  at  high 
prices.  Not  only  the  favorite  objects  of  rich  collectors,  such 
as  rare  paintings  and  books,  belong  in  this  class,  but  many 
others  which  are  not  commonly  thought  of  as  belonging  there. 
Handsome  houses,  fashionable  clothes,  even  choice  food,  get 
no  small  part  of  their  power  of  yielding  utilities  from  their 
satisfying  the  sense  of  distinction.  As  to  all  these,  total  utility 
and  consumer's  surplus  are  highly  elusive. 

Another  qualification  concerns  articles  at  the  other  end  of 
the  scale,  —  things  of  simple  necessity.  Measured  in  terms 
of  the  prices  that  would  be  given  for  the  early  doses,  con- 
sumer's surplus  is  very  high  for  bread,  clothing,  houseroom,  — 
for  the  minimum  of  food,  raiment,  and  shelter.  Rather  than 
dispense  with  these,  anything  would  be  given ;  life  itself  de- 
pends on  them.  Total  utility  and  consumer's  rent  may  be 
calculated  to  be  infinite.  Certain  it  is  that,  were  they  to 
become  very  scarce,  their  price  would  go  to  a  very  high  range ; 
and  this,  irrespective  of  whether  there  were  or  were  not  in- 
equalities of  incomes  among  the  purchasers.  But  a  question 


VALUE  AND   UTILITY  131 

may  be  raised  as  to  the  nature  of  the  utilities  derived  from 
these  necessaries.  The  satisfaction  they  give  is  of  a  negative 
sort.  The  chronicler  of  Lewis  and  Clark's  expedition  across 
the  American  continent  narrates  that  at  one  stage  the  explorers 
subsisted  on  dried  salmon  in  the  form  of  a  tasteless  powder, 
so  unappetizing  that  only  the  absplutely  necessary  amount  was 
eaten.  Some  such  situation  is  in  the  mind  of  an  ingenious  and 
stimulating  thinker,  Professor  Patten,  who  has  distinguished 
between  a  "pain  economy"  and  a  "pleasure  economy." 
The  first  phrase  describes  that  economic  stage  in  which  the 
efforts  of  man  suffice  only  to  yield  the  indispensable  minimum ; 
to  prevent  hunger,  thirst,  freezing;  to  ward  off  pain,  not  to 
yield  satisfaction.  The  second  describes  that  better  stage 
when  the  first  elemental  wants  have  been  attended  to,  and 
positive  enjoyment  begins ;  when  food  is  appetizing  as  well 
as  sufficient,  when  clothing  and  houseroom  are  attractive. 
Now,  in  reckoning  total  utility  and  consumer's  surplus,  we  do 
well  to  begin  only  when  this  second  stage  has  been  reached. 
Let  those  utilities  which  are  of  the  indispensable  sort  be  set 
aside.  Only  where  the  stage  has  been  reached  of  possible 
comfort,  of  some  choice  in  the  direction  of  expenditure,  can 
there  be  anything  in  the  nature  of  a  real  surplus  of  satisfaction 
for  the  consumer. 

But  this  is  true  not  only  of  absolute  necessaries,  but  in  a 
good  degree  of  conventional  necessaries.  Equipages  and  horses 
are  conventional  necessaries  for  many  members  of  the  Conti- 
nental aristocracy.  They  would  be  immensely  missed  if  the 
individual  had  to  give  them  up.  Yet  the  real  enjoyment  from 
them  is  doubtful.  So  it  is  with  the  starched  linen  and  close- 
fitting  clothes  of  the  well-to-do,  which  are  insignia  of  the 
wearer's  exemption  from  manual  labor.  The  satisfaction  from 
them  is  chiefly  negative ;  their  loss  would  be  more  keenly  felt 
than  their  presence  is  enjoyed.  Positive  satisfaction  is  indi- 
cated in  very  uncertain  degree  by  the  price  which  under  the 
stress  of  convention  the  individual  would  pay  rather  than  do 
without  such  things. 


132  VALUE  AND  EXCHANGE 

Not  the  least  of  the  difficulties  in  the  way  of  measuring 
utilities  by  potential  prices  is  the  practical  one  that  we  have 
no  means  of  knowing  what  are  the  prices  that  would  be  paid 
for  the  several  installments  of  a  commodity.  In  our  illustrative 
case  it  has  been  assumed  that  the  first  orange  would  be  so 
greatly  enjoyed  as  to  command  a  price  of  50  cents.  But  in 
hardly  any  actual  case  do  we  know  what  price  would  have 
been  fetched  by  the  first  installment,  or  by  a  series  of  earlier 
installments.  All  we  know  is  that  they  would  command  much 
more  than  that  settled  by  marginal  utility  for  the  actual  supply. 
We  have  some  information  (though  not  very  much  even  here) 
regarding  the  variations  of  prices  in  the  neighborhood  of  the 
range  familiar  to  us.  We  observe  how  oranges,  cigars,  bread, 
meat,  sugar,  go  up  and  down  as  the  quantities  become  some- 
what greater  or  less  than  those  usually  put  on  the  market. 
But  we  have  no  precise  knowledge  of  what  would  happen  if 
the  quantity  of  any  one  of  these  varied  very  greatly  from  the 
usual  amount.  Statistics  of  prices,  however  perfected,  throw 
no  light  on  the  highest  range  that  would  be  paid  if  supply 
became  very  small. 

These  accumulated  difficulties  make  it  impossible  to  meas- 
ure in  any  precise  way  total  utility  or  consumer's  surplus. 
The  figures  which  have  been  given  for  illustration  are  useful  in 
making  the  conceptions  clear,  but  are  misleading  in  that  they 
imply  accuracy  of  measurement.  We  cannot  set  down  the 
complete  price  schedule ;  and  even  if  we  could,  the  differences 
in  incomes,  the  illusiveness  of  prestige,  the  doubtful  satisfac- 
tion of  a  pain  economy,  combine  to  render  a  calculation  of  real 
enjoyment  impracticable.  We  cannot  measure  with  any  ap- 
proach to  accuracy  the  satisfactions  got  from  wealth. 

None  the  less,  total  utility  and  consumer's  surplus  are  not 
fanciful.  That  they  are  real,  is  shown  by  their  accord  with 
familiar  phrases.  We  often  say  that  we  get  a  thing  for  less 
than  it  is  worth  to  us,  meaning  that  what  we  give  for  it  offers 
less  satisfaction  than  the  thing  we  buy.  This  is  merely  stated 
with  more  care  and  precision  when  we  say  that  a  consumer's 


VALUE  AND  UTILITY  133 

surplus  is  secured.  Though  that  surplus  may  not  be  clear  either 
at  the  lower  end  of  the  scale  of  consumption,  where  bare  neces- 
saries alone  are  bought,  or  at  the  upper  end,  where  mere  vanity 
is  satisfied,  it  is  unmistakable  with  what  may  be  called  the 
true  enjoyments  of  life.  A  varied  diet,  abundant  houseroom, 
clothing  and  fittings  that  permanently  please  the  taste,  the 
gratification  which  all  men  get  from  the  mimic  arts,  distraction 
coming  after  monotonous  work,  the  pleasures  of  the  intellect, 
—  these  are  things  not  less  enjoyed  when  abundant  and  cheap. 
They  often  have  a  utility  much  greater  than  is  indicated  by 
the  price  paid  for  them.  Though  their  utility  be  not  susceptible 
of  measurement,  total  utility  is  certainly  large,  and  consumer's 
surplus  is  correspondingly  large. 

§  6.  The  discussion  of  utility,  total  utility,  and  consumer's 
surplus  leads  to  another  question,  How  state  and  measure 
the  income  of  a  community  ? 

An  individual  usually  thinks  of  his  income,  and  measures  it, 
in  terms  of  money.  Similarly,  the  income  of  a  community  is 
usually  stated  in  terms  of  money.  So  long  as  the  prices  of 
commodities  and  services  remain  the  same,  this  mode  of  esti- 
mating income  is  for  most  purposes  sufficient.  The  condition 
stated — of  stable  prices — is  obviously  important.  If  all  money 
incomes  double,  and  all  prices  also  double,  the  community  is 
no  better  off  than  before.  It  simply  conducts  its  exchanges 
with  a  different  scale  for  the  medium  of  exchange. 

Hence  we  proceed  naturally  to  the  next  step.  Money  in- 
come is  significant  simply  as  a  way  of  measuring  the  quantity 
of  the  things  which  the  money  buys.  We  may  think,  therefore, 
of  real  income  in  contrast  to  money  income,  — of  the  necessities, 
conveniences,  and  luxuries  of  life.  We  must  reckon,  also,  as 
part  of  real  income,  the  services  of  those  who  used  to  be  called 
"unproductive,"  —  actors,  musicians,  servants,  and  so  on. 
The  more  we  can  get  of  such  "real"  income,  of  all  kinds,  the 
more  prosperous  we  are  as  individuals  and  as  a  community. 

But  we  may  go  a  step  beyond.     We  have  seen  l  that  the 

i  See  Book  I,  Chapter  2,  §  2. 


134  VALUE  AND  EXCHANGE 

act  of  production  consists  in  the  creation  of  utilities.  Now, 
just  as  all  production  in  the  last  analysis  consists  in  the  creation 
of  utilities,  so  all  income  consists  in  the  utilities  or  satisfactions 
created.  Economic  goods  are  not  ends  in  themselves,  but 
means  to  the  end  of  satisfying  wants.  In  a  preceding  chapter, 
we  have  distinguished  between  capital  and  wealth  which  is  not 
capital,  or  (in  other  phraseology)  between  consumer's  wealth 
and  producer's  capital.  But  consumer's  wealth,  which  we 
may  treat  in  one  sense  as  "real"  income,  is  an  instrument  no 
less  than  producer's  capital.  It,  too,  is  a  means,  not  an  end. 
Our  food,  clothing,  furniture,  may  be  said  to  yield  psychic 
income.  They  shed  utilities,  so  to  speak,  as  long  as  they 
last.  In  the  final  analysis,  the  income  of  an  individual  or  of  a 
community  consists  of  the  sum  of  utilities  steadily  accruing 
from  its  store  of  economic  goods.  It  consists,  that  is,  of  the 
total  utility  of  all  its  goods. 

Nevertheless,  for  almost  all  purposes  of  economic  study,  it 
is  best  to  content  ourselves  with  a  statement,  and  an  attempt 
at  measurement,  in  terms  not  of  utility  but  of  money  income 
or  of  real  income.  The  reason  for  this  rejection  of  a  principle 
which  is  in  itself  sound  lies  in  the  conclusion  just  reached  re- 
garding total  utility  and  consumer's  surplus  :  they  cannot  be 
measured. 

The  other  ways  of  stating  and  measuring  income  lead  to 
results  of  some  certainty.  We  can  measure  money  income. 
Though  our  statistics  for  the  total  money  income  of  (say)  the 
people  of  the  United  States  are  far  from  complete,  the  task  of 
ascertaining  that  income  is  not  hopeless.  Indeed,  it  has  been 
accomplished  for  some  countries  with  sufficient  accuracy.1  We 
can  also  measure  the  general  range  of  prices.  We  know,  there- 
fore, whether  a  given  sum  of  money  incomes  at  one  time  means 
more  than  a  given  sum  at  another  time.  If  we  know  that 
money  incomes  have  increased,  and  that  the  range  of  prices 
is  unchanged,  we  are  sure  that  real  income,  in  terms  of  con- 
sumable commodities,  has  increased. 

1  See,  for  a  recent  example,  R.  E.  May's  estimate  of  the  money  income  of 
the  German  people  in  the  Jahrbuch  fiir  Gesetzgebung,  1909,  Heft  4. 


VALUE  AND  UTILITY  135 

Further,  we  can  do  something  toward  measuring  "real" 
income  directly.  We  can  ascertain  what  has  been  the  con- 
sumption, per  head  of  population,  at  different  times,  of  such 
articles  as  flour,  sugar,  tea,  coffee,  cotton,  wool,  and  the  like. 
The  results  give  indications  of  value  regarding  the  increase  of 
income  in  terms  of  commodities.  We  know  that  the  average 
consumption  of  such  things  has  much  increased  in  recent  times, 
and  that  material  welfare  has  so  far  advanced. 

But  how  far  total  utility  or  "psychic  income"  has  increased, 
we  have  no  accurate  notion.  We  may  feel  sure  that  it  has 
increased  in  some  degree ;  but  whether  in  the  same  degree  as 
consumer's  wealth,  or  in  less,  or  even  in  greater,  degree,1  we 
do  not  know.  We  cannot  measure  how  great  total  utility 
was  before  the  increased  supply  of  economic  goods,  or  how 
great  after.  The  supply  of  the  things  which  minister  to  en- 
joyment can  be  measured,  but  not  enjoyment  itself.  Virtually 
all  problems  of  legislation  and  applied  economics  can  be  settled, 
and  habitually  are  settled,  according  to  the  results  in  terms 
of  the  former  sort  of  income.  Hence  we  do  best,  for  almost 
all  economic  reasoning,  not  to  go  beyond  the  tangible  and 
measurable  facts  of  consumer's  wealth.  Even  though  consumer's 
goods  be  but  a  sort  of  capital,  and  even  though  total  utility  be,  in 
the  last  analysis,  the  true  income,  the  only  kind  of  income 
about  which  we  can  reach  results  of  quantitative  accuracy  is 
that  "real"  income  which  consists  of  enjoyable  things. 

§  7.  The  principle  of  diminishing  utility,  if  applied  unflinch- 
ingly, leads  to  the  conclusion  that  inequality  of  incomes 
brings  a  less  sum  of  human  happiness  than  equality  of  incomes, 
and  that  the  greater  the  inequality,  the  less  the  approach  to 
maximum  happiness.  If  additional  increments  of  any  com- 
modity yield  less  enjoyment  than  preceding  increments,  the 
same  is  true  of  increments  of  income  in  general.  A  man  who 

1  If  we  accept  the  distinction  between  a  pain  economy  and  a  pleasure  economy, 
and  begin  to  reckon  total  utility  and  consumer's  surplus  only  when  a  surplus 
over  necessaries  appears,  we  may  conclude  that  for  a  considerable  stage  after 
the  first  emergence  of  a  surplus,  total  utility  increases  in  greater  degree  than 
consumer's  wealth. 


136  VALUE  AND  EXCHANGE 

already  has  five  oranges  gains  less  from  a  sixth  than  he  who 
has  but  one  orange  gains  from  a  second.  A  man  who  has  an 
income  of  $10,000  gains  less  from  an  additional  $100  than 
does  the  man  who  has  an  income  of  $1000.  This  is  stated  in 
another  way  in  the  proposition  that  gambling  between  persons 
of  equal  income  always  brings  an  economic  loss.  If  two  men, 
each  having  $1000,  bet  $100,  the  gain  to  the  winner  from  the 
increase  of  his  possessions  to  $1100  is  less  than  the  loss  to  the 
loser  from  the  drop  of  his  possessions  to  $900.  All  this  follows 
directly  from  the  hedonistic  calculus,  —  from  the  principle  of 
diminishing  utility. 

We  have  just  seen  that  the  hedonistic  calculus  is  not  to  be 
applied  unflinchingly.  It  needs  to  be  qualified,  for  example,  in 
its  application  to  the  necessaries  of  life,  —  to  pain  economy  and 
pleasure  economy.  Additions  of  income  (that  is,  of  goods 
purchasable)  which  come  after  the  first  needs  of  bare  existence 
have  been  met,  may  mean  not  only  an  increase  of  happiness,  but 
a  more  than  proportionate  increase.  Hence  if  one  half  of  a 
people  have  a  considerable  surplus  over  necessaries,  and  the 
rest  the  bare  necessaries  only,  the  sum  of  enjoyments  may  be 
greater  than  if  all  had  the  same  income,  —  if  the  surplus  were 
spread  thin  over  the  entire  mass. 

And  it  hardly  needs  to  be  said  that  the  hedonistic  calculus, 
even  where  it  does  lead  clearly  to  the  conclusion  that  enjoy- 
ment is  subject  to  diminishing  return,  does  not  tell  the  whole 
story  of  human  happiness.  One  of  the  unfailing  sources  of 
satisfaction,  deep-rooted  in  human  nature,  is  the  response  to 
the  instincts  of  emulation  and  distinction.  But  distinction 
implies  inequality.  Though  there  may  be  distinction  and 
inequality  in  other  ways,  —  in  rank  or  fame,  —  difference  in 
economic  possessions  has  been  an  immense  stimulus  and  an 
immense  resource  to  almost  all  men.  The  spice  and  flavor  of 
life  would  be  gone  with  flat  equality. 

None  the  less,  it  remains  true  that  there  is  an  opposition  be- 
tween inequality  and  maximum  happiness.  The  opposition 
becomes  obvious  when  there  is  very  great  inequality.  High  dis- 


VALUE  AND   UTILITY  137 

parity  of  incomes  means  a  net  loss  in  happiness ;  the  rich  gain 
less  than  the  poor  lose.  Though  some  emulation  and  distinction 
be  essential  to  a  full  and  happy  life,  and  though  some  inequality  of 
income  be  a  natural  consequence  of  distinction,  such  great 
inequalities  as  are  familiar  in  modern  society,  and  indeed  in 
all  societies  advanced  much  beyond  barbarism,  cannot  possibly 
bring  the  most  effective  distribution  of  the  material  sources  of 
enjoyment.  Emulation  in  ostentation  palls ;  it  is  the  least  last- 
ing of  all  the  satisfactions  derived  from  distinction.  The  con- 
sciousness, more  or  less  obscure,  of  the  inconsistency  between 
maximum  happiness  and  great  inequality  underlies  the  whole 
modern  social  movement ;  for  essentially  this  movement  has 
for  its  goal  a  more  equal  distribution  of  income.  From  this  flow 
the  characteristic  tendencies  of  our  time,  —  curbing  of  monopo- 
lies, extension  of  government  industry,  labor  legislation,  progres- 
sive taxation ;  last,  but  not  least,  socialism.  Inequality  may  be, 
and  probably  is,  an  indispensable  spur  to  the  full  application  of 
men's  best  faculties,  and  an  inevitable  outcome  of  free  and  vigor- 
ous industry.  But  prima  fade  it  does  not  lead  to  the  best 
distribution  of  well-being.  It  is  always  on  the  defensive ;  and 
the  greater  and  more  lasting  it  is,  the  more  difficult  is  its  defense. 


CHAPTER  10 

MARKET  VALUE.     DEMAND  AND  SUPPLY 

§  1.  In  the  preceding  chapter  the  first  principle  of  value  has 
already  been  stated.  The  value  of  an  article  depends  on  its  mar- 
ginal utility.  It  is  the  price  at  which  the  last  installment  can  be 
disposed  of,  —  the  price  that  settles,  in  turn,  under  the  ordinary 
conditions  of  competition  in  the  market,  the  price  at  which  the 
whole  supply  will  be  sold.  It  remains  to  illustrate  this  prin- 
ciple further,  and  to  explain  in  what  manner  it  operates  in  the 
complexities  of  actual  life. 

Let  us  first  illustrate  the  main  principle  graphically.  On 
Figure  1,  prices  are  measured  along  the  perpendicular  axis  Y; 
quantities,  i.e.  the  several  installments  offered  in  the  market,  are 
measured  on  the  horizontal  axis  OX.  Let  it  be  supposed  that 
the  first  dose,  say  of  sugar,  is  represented  by  the  horizontal  line 
OA,  and  that  this  dose  would  command  the  price  OP.  Its  value 
would  then  be  indicated  by  the  area  OP  A' A, — the  quantity 
multiplied  by  the  price.  Suppose  now  a  second  dose  to  be 
offered,  indicated  by  the  line  OB.  Under  the  influence  of  the 
principle  of  diminishing  utility,  its  price  would  sink  to  OP', 
and  the  whole  supply  would  now  be  sold  at  this  price  (or  rather, 
as  will  presently  be  explained,  at  no  higher  price  than  this). 
The  total  value  of  the  increased  supply  would  now  be  indicated 
by  the  area  OP'B'B.  Add  now  another  dose,  the  supply  being 
OC ;  the  price  sinks  again,  and  the  value  of  the  whole  supply 
is  OP"C'C.  And  so  on,  with  the  supply  OD,  the  price  will  be 
OP'",  and  the  whole  value  OP'"D'D,  and  with  the  supply 
OE,  the  price  will  be  OP""  and  the  whole  value  OP""E'E. 

Strictly  speaking,  under  the  conditions  here  assumed,  we 
should  not  know  that  the  price  for  the  quantity  OB,  for  example, 

138 


MARKET  VALUE.    DEMAND  AND 'SUPPLY        139 

was  fixed  at  the  amount  indicated  by  the  lines  OP'  or  BB'. 
We  should  only  know  that  it  was  not  higher  than  OP'  and  not 
lower  than  OP"  (CC").  In  order  to  induce  the  supply  OB  to 
be  taken  off,  the  price  must  be  at  least  as  low  as  OP' ;  otherwise, 
the  buyer  would  not  take  it.  But  if  the  buyer  offered  less  than 


A' 

.n' 

C' 

n' 

p' 

p' 

p" 
p'" 
p"" 

c 

U 

«> 

)        A        B        C        D        L 
Fio.  1. 

OP',  the  seller  would  still  rather  dispose  of  his  supply  than  have 
it  left  on  his  hands ;  and  until  another  potential  buyer  came  on 
the  scene,  there  is  no  telling  what  price  the  seller  might  not 
accept.  But  if  another  buyer  comes,  to  whom  the  dose  has  the 
utility  measured  by  OP",  and  who  is  willing  to  pay  the  price  so 
measured,  the  seller  can  compel  the  second  buyer,  stationed  at 

B,  to  pay  at  least  as  much  as  the  third  competitor,  stationed  at 

C,  would  offer.     Price,  therefore,  would  be  somewhere  between 
OP'  and  OP",  or  somewhere   between  BB'  and  CC'.     So  in 
each  of  the  successive  stages.     The  price  must  be  at  least  low 
enough  to  tempt  the  last  buyer,  who  must  be  called  in  to  dispose 
of  the  whole  supply  offered.     It  may  go  a  bit  lower  than  this, 
until  the  point  is  reached  at  which  a  new  buyer  would  enter  and 
prevent  the  more  desirous  buyer  —  the  more  "capable"  buyer, 
as  he  has  sometimes  been  called  —  from  beating  the  seller  down. 
If  there  be  a  considerable  difference  between  the  utilities  of  the 


140  VALUE  AND  EXCHANGE 

installments   to    successive  buyers,    there  is    a  considerable 
range  within  which  price  is  indeterminate. 
We  have  already  noted,  however,  that  in  the  ordinary  course 


FIG.  2. 

of  business  dealings  there  are  no  such  abrupt  stages  in  demand 
as  the  preceding  diagram  assumes.  There  are  not  a  paltry  half- 
dozen  purchasers,  and  a  few  pieces  on  sale,  for  any  given  article. 
There  are  many  buyers,  to  whom  great  supplies  are  offered. 
Among  the  many  buyers,  there  are  always  some  just  ready  to 
step  forward;  some  to  whom  the  utility  of  the  additional 
dose  is  only  a  shade  less  than  was  the  utility  of  the  previous 
dose,  and  who  are  therefore  called  into  the  active  purchasing 
market  by  the  lower  price.  This  situation  is  described,  in  the 
technical  language  which  economists  have  found  convenient, 
by  saying  that  demand  is  continuous.  Where  there  are  gaps  be- 
tween the  utilities  to  different  purchasers,  and  consequently 
between  the  prices  they  are  willing  to  pay,  demand  is  discon- 
tinuous. The  successive  steps  from  A'  to  B',  C",  D',  E'  in 
Figure  1  indicated  such  discontinuity  of  demand.  The  nearer 
together  these  points  are,  the  smaller  is  each  step,  and  the  less  is 


MARKET  VALUE.    DEMAND  AND  SUPPLY        141 

the  range  within  which  price  is  indeterminate.  For  the  immense 
majority  of  dealings  in  modern  communities,  the  points  are  so 
near  together,  —  the  gradation  of  utility  and  demand  is  so  close, 
—  that  they  may  be  represented  as  joined  into  a  line  or  curve. 
That  curve,  on  a  diagram  such  as  is  commonly  used  in  graphic 
illustrations  of  these  principles,  always  has  a  smooth  downward 
inclination  from  left  to  right,  like  the  unbroken  line  DD'  in 
Figure  2.  It  indicates  that  successive  doses  of  any  article  have 
gradually  diminishing  utility,  and  must  be  offered  at  prices 
that  insensibly  become  lower  and  lower  as  greater  quantities 
are  disposed  of.  It  is  called  the  demand  curve. 

The  shape  which  that  curve  assumes  indicates  the  nature  of 
the  demand  for  the  commodity.  If  it  descends  slowly,  — as  does 
the  dotted  line  ee'  in  Figure  2,  —  it  indicates  that,  as  greater  quan- 
tities are  offered  on  the  market,  new  purchasers  appear  readily 
and  the  decline  in  price  is  slow.  The  demand  for  the  commodity 
is  then  said  to  be  elastic.  On  the  other  hand,  a  curve  descending 
quickly,  like  the  broken  line  ii',  in  Figure  2,  indicates  that  util- 
ity or  purchasing  power  diminishes  rapidly,  that  new  purchasers 
do  not  readily  appear,  and  that  the  decline  in  price  with  increas- 
ing supply  is  abrupt.  In  such  a  case  the  demand  for  the  com- 
modity is  said  to  be  inelastic  :  consumption  does  not  respond 
promptly  to  a  lowering  of  prise.  The  cause  of  inelasticity 
must  be,  in  some  degree,  rapid  diminution  of  the  utility  of  added 
installments ;  but  this  cause  may  be  accentuated  by  inequality  in 
means.  If  some  purchasers  are  very  rich,  others  well-to-do, 
many  others  poor,  commodities  may  meet  a  highly  inelastic 
demand  in  the  market,  but  not  necessarily  suffer  a  correspond- 
ing diminution  in  their  power  of  yielding  enjoyments  to  man- 
kind. 

The  demand  for  necessaries  is  inelastic.  A  certain  quantity 
of  bread  will  be  bought,  whatever  the  price.  No  doubt  a  high 
price  will  in  some  degree  check  consumption,  and  a  low  price 
will  lead  to  more  liberal  or  careless  use.  But  when  the  indispens- 
able supply  has  once  been  got,  the  decline  in  utility  from  greater 
quantities  is  rapid.  For  articles  of  this  sort,  a  comparatively 


142  VALUE  AND  EXCHANGE 

small  shortage  in  supply  will  cause  a  large  increase  in  price, 
while  a  comparatively  small  redundancy  will  cause  a  rapid 
decline.  The  sharp  inclination  of  the  demand  curve  ii'  is  the 
graphic  representation  of  the  inelastic  demand  for  necessaries 
and  oi  the  abrupt  fluctuations  in  price  under  slight  changes 
in  supply, 

Any  article  which,  though  not  necessary,  is  yet  clung  to  with  per- 
sistence by  consumers,  has  a  similarly  inelastic  demand.  Meat,  for 
example,  though  not  a  necessary,  has  an  inelastic  demand  among 
the  well-to-do.  On  the  other  hand,  the  substantial  comforts  of 
life  —  things  not  indispensable,  yet  prized  by  all  the  world  — 
often  have  an  elastic  demand.  Such  are  those  articles  of  food 
which,  though  not  necessaries,  please  by  their  flavor  and  variety. 
For  almost  all  except  the  well-to-do  meat  is  such  an  article.  In 
the  upper  part  of  the  supply  it  has  an  inelastic  demand,  in  the 
lower  part  a  very  elastic  demand.  Sugar,  fruits,  vegetables,  tea, 
coffee,  and  cocoa  have  probably  an  elastic  demand  through- 
out the  range  of  supply ;  so  have  books,  furniture,  houseroom, 
clean  and  decent  clothing. 

In  general,  elasticity  of  demand  is  increased  by  an  equal  dis- 
tribution of  wealth,  while  an  unequal  distribution  leads  to  in- 
elasticity in  demand.  This  effect  of  inequality  illustrates  once 
again  the  caution  which  needs  to  be  observed  in  applying  the 
principle  of  diminishing  utility  to  the  phenomena  of  value  as  they 
appear  in  modern  communities.  If  all  people  had  the  same  in- 
comes, diminishing  utility  would  be  the  one  cause  acting  on  the 
elasticity  of  demand,  and  the  inclination  of  the  demand  curve 
would  be  significant  of  the  rate  of  .diminution  in  the  enjoyments 
yielded  by  successive  increments.  In  fact,  the  demand  curve  is 
much  affected  by  the  circumstance  that  persons  of  means  can  af- 
ford to  bid  high  for  the  first  increments,  while  the  great  number 
of  those  with  small  means  cannot  bid  until  a  low  price  is  reached. 
The  lower  bids  of  the  latter  —  signified  by  a  sharply  descending 
demand  curve — mean  a  diminution  not  so  much  in  enjoyments  as 
in  money  means.  This  qualification  must  be  borne  in  mind  when, 
in  the  succeeding  pages,  value  is  spoken  of  as  depending  on  mar- 


MARKET  VALUE.    DEMAND  AND  SUPPLY        143 

ginal  utility ;  that  phrase  being  used,  for  brevity,  to  indicate 
the  complex  conditions  on  which  depends  the  price  fetched  by 
the  last  increment  of  a  supply. 

§  2.  We  proceed  to  consider  now  the  mode  in  which  the  value 
or  price  of  an  article  is  determined  at  any  particular  time,  —  the 
problem  of  market  value. 

Suppose  the  supply  of  a  commodity  to  be  fixed ;  suppose  it  to 
be  offered  on  the  market  by  competing  sellers ;  suppose  it  all  to 
be  offered  without  reserve.  Then  the  value  of  that  commodity 
will  be  determined  by  its  marginal  utility.  If  all  is  not  sold  at 
that  price  by  the  competing  sellers,  some  part  of  the  stock  will  not 
be  disposed  of.  This  situation  is  graphically  represented  in  Fig- 
ure 3.  Given  a  supply  OS,  the  resulting  price  will  be  at  the  point 
where  the  perpendicular  line  SS'  will  cut  the  demand  curve  DD'. 
That  line  (SSf  —  OP)  measures  the  marginal  utility  of  the  supply 
OS,  and  so  measures  the  price  at  which  that  supply  will  be  sold. 

The  total  exchange  value  of  the  supply  is  indicated  by  the  area 
OPS'S  —  the  supply  multiplied  by  the  price.  Total  utility  is 
indicated  by  the  irregular  area  DOSS' ;  consumer's  surplus  by 
the  (more  or  less  triangular)  area  DPS'.  Those  purchasers  who, 
rather  than  go  without  the  article,  would  have  been  willing  under 
stress  to  pay  a  higher  price  than  SS'  —  as  high  as  OD  —  secure 
some  surplus  of  satisfaction. 

The  same  proposition,  on  the  mode  in  which  the  value  of  an 
article  at  any  given  time  is  determined,  was  stated  by  the  older 
writers  in  a  somewhat  different  way.  They  said  that  market 
value  was  settled  by  the  equation  of  supply  and  demand.  The 
everyday  way  of  putting  it  is  to  say  simply  that  the  value 
of  a  thing  is  determined  by  supply  and  demand.  This  is  loose, 
since  it  implies  that  supply  and  demand  are  causes  that  act  in- 
dependently, and  are  not  themselves  influenced  by  price.  But 
demand,  in  the  sort  of  case  here  supposed,  is  certainly  affected 
by  price.  The  lower  the  price  of  an  article,  the  more  of  it 
will  be  demanded;  the  higher  the  price,  the  less  will  be  de- 
manded. To  say  that  price  depends  on  demand,  therefore,  seems 
to  be  reasoning  in  a  circle ;  since,  if  price  is  affected  by  demand, 


144 


VALUE  AND  EXCHANGE 


demand  is  no  less  affected  by  price.  Hence  the  more  careful 
phrase  just  quoted ;  the  equation  of  supply  and  demand.  Given  a 
fixed  supply,  there  is  one  price  at  which  the  quantity  demanded 
will  be  just  equal  to  this  quantity  supplied.  To  assume  that 
there  is  one  such  price,  and  not  more  than  one,  is  to  assume  con- 
tinuity of  demand,  as  explained  in  the  preceding  section, — an  as- 
sumption that  holds  good  of  the  vast  majority  of  articles  bought 


and  sold  in  the  markets.  This  one  price  evidently  represents  the 
marginal  utility  of  the  supply.  Though  the  phrase  "marginal 
utility  "  was  not  used  by  the  older  writers,  their  version  of  an 
equation  of  demand  and  supply  states  substantially  the  same 
proposition  as  the  more  modern  one  which  reasons  on  the  basis 
of  diminishing  utility  and  marginal  utility. 

§  3.  In  both  of  these  statements  of  the  principle  of  market 
value,  —  the  older  one  of  an  equation  and  the  newer  one  of  the 
marginal  utility  of  supply,  —  the  underlying  assumption  is 
that  a  fixed  quantity  is  put  on  the  market.  But  is  this  assump- 
tion tenable?  Does  it  conform  to  the  usual  state  of  facts? 
We  have  just  said  that  demand,  in  the  sense  of  quantity  de- 


MARKET  VALUE.     DEMAND  AND  SUPPLY        145 

manded,  is  not  independent  of  price.  Is  not  the  same  true  of 
supply?  In  the  ordinary  case,  it  is  hardly  accurate  to  say 
that  the  quantity  offered  in  the  market  is  fixed,  and  is  inde- 
pendent of  price.  As  price  goes  higher,  more  sellers  will  be 
tempted  to  offer  their  wares,  and  supply  will  become  larger. 
As  prices  go  lower,  supply  will  become  smaller.  Must  not  the 
theory  of  market  value  be  adjusted  to  variable  supply  as  well 
as  to  variable  demand? 

It  is  true  that  in  some  instances  the  supposition  of  a  fixed 
supply  is  clearly  in  accord  with  the  facts.  When  a  large  crop 
of  strawberries  comes  on  the  market,  it  must  be  disposed  of 
once  for  all.  There  is  no  keeping  back  any  part  of  the  supply 
of  a  perishable  commodity.  The  total  quantity  on  hand  must 
be  disposed  of  for  what  it  will  fetch,  • —  for  the  marginal  price. 
Not  very  long  ago,  the  list  of  commodities  of  this  kind  was  a 
large  one;  it  included  fresh  fish,  all  vegetables  and  fruits, 
even  meat.  But  modern  improvements  for  the  preservation 
of  most  such  things,  through  cold  storage  and  canning,  have 
greatly  shortened  the  list.  Most  commodities  are  not  put  on 
sale  with  headlong  suddenness.  They  are  offered  in  install- 
ments. They  come  into  the  market  in  a  flow  or  stream,  not  as 
an  abruptly  offered  stock.  The  rate  at  which  they  come  in, 
and  the  amount  which  will  be  offered  at  any  given  time,  depend 
on  the  price.  A  higher  price  quickens  the  flow  and  leads  to 
larger  supply ;  a  lower  price  checks  the  flow. 

It  is  not  difficult  to  adjust  the  theory  of  market  value  to  the 
case  of  variable  supply.  On  Figure  4,  let  SSf  represent  the 
conditions  of  a  supply  that  varies  with  price,  becoming  greater 
as  price  rises  and  smaller  as  price  falls.  Here,  as  on  the  pre- 
vious figures,  quantities  are  measured  horizontally  along  the. 
axis  OX  or  parallel  to  it,  and  prices  perpendicularly  along  the 
axis  OK  or  parallel  to  it.  At  the  price  SA,  we  may  suppose 
the  quantity  OA  to  be  forthcoming  on  the  market.  As  the 
price  rises,  the  quantity  increases.  At  the  price  PP',  the 
quantity  offered  is  OP' ;  at  the  price  S'A',  the  quantity  offered 
is  OA'.  Evidently  the  line  SPS',  which  is  the  supply  curve,  has 


146 


VALUE  AND  EXCHANGE 


an  upward  inclination,  the  reverse  of  the  inclination  of  the 
demand  curve  DD'.  A  rise  in  price,  which  causes  the  quan- 
tity demanded  to  become  less,  causes  the  quantity  offered  to 
become  greater. 

The  supply  and  demand  curves,  moving  in  opposite  direc- 
tions, must  meet;  and  in  our  figure  they  meet  at  P.  The 
price  PP'  is  the  equilibrium  price,  the  market  price  fixed  by  the 
play  of  varying  supply  and  demand.  At  that  point  the  quantity 
offered  is  equal  to  the  quantity  demanded:  the  equation  is 
Y 


FIG.  4. 

satisfied.  If  a  higher  price  is  asked,  the  quantity  demanded 
will  be  less  and  the  quantity  offered  will  be  greater.  Sellers 
will  put  on  the  market  more  than  buyers  will  take ;  price  will 
fall;  some  sellers  will  then  withdraw  and  some  buyers  will 
come  in,  until  equilibrium  is  reached.  And  so  in  the  reverse 
case :  at  any  lower  price,  some  sellers  will  withdraw,  some 
buyers  will  be  tempted  in,  and  readjustment  will  again  bring 
the  price  to  the  point  of  equilibrium  PP'. 

§  4.   It  has  just  been  said  that  of  these  two  modes  of  state- 
ment —  the  one  proceeding  on  the  supposition  of  a  fixed  supply, 


MARKET  VALUE.    DEMAND  AND  SUPPLY        147 

the  other  on  that  of  a  variable  supply  —  the  second  is  more  in 
accord  with  the  facts.  Yet  the  first  also  is  so  in  accord.  Both 
must  be  had  in  mind  for  an  understanding  of  the  course  of 
prices  in  a  market. 

On  any  given  day,  in  a  well-organized  market,  the  actual 
settlement  of  market  price  undoubtedly  takes  place  through 
an  adjustment  of  supply  as  well  as  through  a  response  from 
demand.  On  the  cotton  exchange  or  the  produce  exchange, 
or  in  any  place  where  brokers  and  dealers  meet,  a  process  of 
higgling  and  bargaining  goes  on.  More  or  less  of  the  article 
is  offered  and  demanded,  with  fluctuations  in  prices  which  are 
usually  within  narrow  limits  on  any  one  day  and  which  result 
in  an  equilibrium  price  for  that  day.  But  this  daily  equilib- 
rium price  is  itself  affected  by  an  underlying  and  more  im- 
portant equilibrium  price.  While  the  amount  which  is  offered 
in  the  market  from  day  to  day — the  supply — varies  consider- 
ably, and  varies  in  response  to  changes  in  price,  the  total  amount 
which  can  be  supplied  over  a  larger  period  usually  is  fixed. 
Take,  as  a  typical  case,  the  price  of  cotton,  which  fluctuates 
on  the  exchanges  from  day  to  day  in  response  to  the  ever 
changing  play  of  offer  and  demand.  The  total  amount  of 
cotton  available  for  the  season  is  not  a  variable  quantity.  It 
is  so  much  and  no  more,  depending  on  the  crop  of  that  season. 
The  price  at  which  the  whole  will  be  disposed  of  depends  on 
its  marginal  utility  or  on  the  equation  of  supply  and  demand 
(whichever  mode  of  statement  be  preferred)  and  is  the  out- 
come of  a  total  supply  which  is  fixed.  The  fluctuations  in  price 
from  day  to  day  oscillate  about  this  seasonal  equilibrium 
price. 

Still  using  the  cotton  market  and  cotton  prices  for  examples, 
we  may  note  that,  while  the  supply  for  the  season  is  fixed,  no 
one  knows  in  advance  with  certainty  just  how  great  that  supply 
is ;  still  less  at  what  price  the  supply,  even  if  accurately  known, 
would  be  disposed  of.  Hence  a  period  of  uncertainty,  of 
rumors  and  guesses,  of  selling  and  buying  by  brokers  and 
dealers  and  manufacturers,  by  any  one  who  chooses  to  operate 


148  VALUE  AND  EXCHANGE 

on  the  cotton  market,  —  in  short,  all  the  phenomena  of  specu- 
lation. Cotton  in  the  United  States  (the  crop  in  this  country 
dominates  the  world  market)  is  picked  in  the  autumn,  and  the 
amount  harvested  is  known  by  December  1.  But  through- 
out the  summer  months  there  are  reports  of  the  condition  of 
the  growing  plants,  which  foreshadow,  though  with  uncertainty, 
the  amount  of  the  coming  crop.  During  the  picking  season 
more  and  more  certainty  is  reached.  Finally,  under  modern 
methods  of  gathering  such  information,  the  amount  comes  to 
be  accurately  known.  Then  arises  the  question  to  what  degree 
the  price  will  be  affected  by  the  amount.  It  is  certain  that  a 
small  crop  will  command  a  higher  price,  a  large  crop  a  smaller 
price.  But  the  conditions  of  demand  or  consumption  are 
fluctuating  from  year  to  year,  no  less  than  the  supply  from 
the  crops.  Just  what  will  be  the  seasonal  equilibrium  price 
for  a  crop  of  a  given  size,  no  one  can  say  in  advance.  It  is 
reached  by  a  succession  of  tentative  market  prices.  From  day 
to  day,  and  from  month  to  month,  the  market  price  is  settled 
by  the  adjustment  of  variable  amounts  offered  in  the  market 
by  dealers.  For  the  season,  it  is  settled  by  the  adjustment  of 
a  fixed  supply  to  the  marginal  price  at  which  the  whole  will  be 
disposed  of. 

It  is  not  to  be  supposed  that  even  on  a  single  day  is  there 
one  price  rigidly  settled  by  the  equilibrium  of  demand  and 
supply.  Even  in  the  most  highly  organized  markets  there 
may  be  simultaneous  sales  at  different  prices ;  and,  where  there 
are  newly  discovered  conditions  affecting  the  seasonal  range, 
such  as  a  crop  report,  there  may  be  considerable  fluctuations 
in  the  course  of  a  day.  These  oscillations  give  the  opportunity 
to  the  astute  bargainer.  Some  buyers,  not  cool-headed  enough 
to  bide  their  time,  will  pay  more  than  the  equilibrium  price. 
On  the  other  hand,  some  sellers,  unduly  anxious  lest  their 
supplies  be  left  on  their  hands,  will  sell  at  less.  The  shrewd 
and  unexcitable  person,  carefully  watching  the  course  of  deal- 
ings, may  buy  at  one  price  from  the  over-eager  sellers  and 
sell  on  the  same  day  at  a  profit  to  over-eager  buyers.  It  is 


MARKET  VALUE.    DEMAND  AND  SUPPLY        149 

sometimes  said  that  all  the  capital  a  speculator  needs  is  a  pencil 
and  a  block  of  paper,  and  all  the  knowledge  he  needs  is  a  knowl- 
edge of  human  nature.  This  is  by  no  means  the  whole  story, 
yet  it  is  true  that  a  certain  faculty  of  judging  human  nature, 
and  an  impassive  demeanor,  are  important  in  the  equipment  of 
the  professional  dealer,  and  play  no  small  part  in  those  specu- 
lative operations  which  are  discussed  in  the  next  chapter. 

The  more  the  actual  dealings  in  a  market  are  confined  to 
persons  who  are  shrewd  and  well-informed,  the  more  probable 
is  it  that  there  will  be  an  exact  equilibrium  price.  And  in  any 
market  where  dealings  are  habitually  conducted  on  a  con- 
siderable scale,  there  will  be  an  equilibrium  price  which,  though 
not  rigid,  is  maintained  between  comparatively  narrow  limits; 
and  that  price  will  represent  the  judgment  then  currently  held 
of  the  probable  seasonal  price.  Here,  as  in  all  economic  analysis, 
we  have  to  do  not  with  hard  and  fast  phenomena,  but  with  the 
wavering  doings  of  human  beings.  For  the  sake  of  bringing 
out  clearly  the  underlying  general  probability  —  a  probability 
which  often  is  so  great  as  to  be  virtually  a  certainty  —  we 
state  our  reasoning  and  conclusions  in  semi-mathematical  form, 
as  in  the  diagrams  and  figures  that  have  preceded.  But  it  must 
be  remembered  that  the  conclusions  hold  good  not  with  mathe- 
matical certainty,  but  simply  as  statements  of  tendencies  to 
which  the  actual  market  conditions  more  or  less  conform. 

What  is  true  of  cotton,  holds  of  other  agricultural  commodi- 
ties, whose  supply  also  is  settled  by  the  crops  of  each  season : 
of  wheat,  corn,  and  other  grains,  of  hay,  flax  and  hemp,  hops, 
sugar,  tea,  coffee.  There  is  always  a  seasonal  price,  around 
which  fluctuate  the  market  prices  for  shorter  periods.  Vir- 
tually this  holds  of  other  commodities  also.  It  is  true  that 
agricultural  commodities  show  more  unmistakably  than  most 
others  the  temporary  fixation  of  supply.  The  supply  of  manu- 
factured commodities  changes  more  smoothly  and  continuously. 
The  amounts  offered  in  the  market  can  often  be  increased  and 
diminished  without  waiting  for  nature's  processes  of  growth. 
But  even  here  there  are  important  limitations.  For  any  givec 


150  VALUE  AND  EXCHANGE 

period  of  moderate  length  —  a  half  year  or  a  year  —  there  is 
something  like  a  fixed  supply.  Iron,  for  example,  is  continu- 
ously produced,  and  the  amount  of  production  responds  in 
some  degree  to  the  fluctuations  in  price.  But  the  quantity 
available  for  any  given  period  depends  on  the  mines  of 
iron  ore  and  of  coal  which  are  open,  and  still  more  on  the 
furnaces  and  works  which  are  ready  to  smelt  and  shape  the 
iron.  The  supply  can  be  increased  or  decreased  only  with 
considerable  difficulty.  It  will  not  readily  decrease,  because 
the  existing  iron  mines  and  works  will  be  kept  going,  unless  the 
prospects  for  profit  are  very  bad  indeed ;  continuous  operation 
is  a  condition  of  almost  any  profit  at  all.  Nor  can  it  be  rapidly 
increased.  New  mines  and  works  can  indeed  be  added,  but 
this  takes  time.  Again,  though  the  output  from  the  existing  con- 
cerns does  not  come  on  the  market  at  any  fixed  or  regular 
rate,  it  is  almost  sure  to  be  offered  for  sale  within  the  current 
season  of  operations.  Thus  a  seasonal  equilibrium  of  supply 
and  demand  establishes  itself.  Around  this  seasonal  price  the 
current  market  prices  fluctuate,  as  varying  amounts  are  offered 
and  demanded  from  day  to  day  and  from  week  to  week. 

Sometimes  dealers,  looking  far  ahead,  carry  stocks  over  a 
considerable  period.  In  this  way,  the  supply  on  hand,  even 
the  seasonal  supply,  may  be  sensibly  affected,  and  the  seasonal 
market  price  may  be  affected  correspondingly.  If,  for  ex- 
ample, the  wheat  crop  in  any  year  is  very  large,  and  the  price 
unusually  low,  some  dealers  may  withdraw  considerable  amounts 
from  sale,  store  them,  and  plan  to  sell  them  at  a  profit  in  the 
next  year,  when  a  smaller  supply  and  higher  prices  may  be 
expected.  But  this  is  a  risky  operation.  It  involves  the 
locking  up  of  large  money  means.  The  next  season  may  again 
bring  a  large  crop.  There  is  the  possibility  that  the  wheat 
held  in  storage  may  spoil  and  become  valueless.  As  a  matter 
of  fact,  very  little  wheat  (in  comparison  with  the  total  supply) 
is  carried  over  from  year  to  year,  and  the  yearly  price  is  deter- 
mined almost  solely  by  the  crop  for  the  time  being.  It  is 
perhaps  otherwise  with  durable  commodities.  If  iron  and 


MARKET  VALUE.    DEMAND  AND  SUPPLY        151 

copper  are  unusually  cheap,  stocks  of  them  may  be  bought 
and  put  aside,  with  a  minimum  expense  for  storage,  and  with 
no  risk  of  deterioration,  in  expectation  of  higher  prices  after  a 
year  or  two.  Yet  even  for  these  durable  articles,  such  opera- 
tions seem  to  be  uncommon.  Most  persons  in  active  busi- 
ness, and  especially  dealers  and  middlemen,  do  not  try  to 
look  far  ahead.  They  study  the  conditions  of  the  present  and 
the  immediate  future,  and  govern  themselves  accordingly. 
The  withdrawal  of  stocks  from  the  seasonal  market  seems  to 
be  no  considerable  factor  in  the  play  of  demand  and  supply. 

§  5.  Strictly  speaking,  the  principle  of  marginal  utility 
applies  to  consumer's  wealth  only.  Capital  yields  no  utilities 
directly.  Materials,  implements,  machinery  are  but  means 
for  procuring  utilities  at  a  later  date.  Their  utility  is  a  derived 
one,  depending  on  the  utility  of  the  consumable  goods  they 
aid  in  making.  Though  the  principle  of  marginal  utility  works 
out  its  results  for  capital  goods  also,  it  does  so  through  an 
intricate  process  and  with  some  complications. 

For  example,  when  the  cotton  crop  is  small,  the  price  of  cotton 
rises ;  marginal  utility  is  greater,  we  say,  for  the  smaller  supply. 
But  the  cotton  is  sold  by  the  planters  and  farmers  first  to  the 
dealers  and  speculators ;  they  sell  to  the  manufacturers ;  these 
again,  through  another  set  of  dealers,  sell  the  cotton  cloth  to 
those  who  wear  it.  It  is  the  satisfactions  got  by  these  ulti- 
mate consumers  that  in  the  end  determine  the  value  of  cotton 
for  a  given  supply.  But  the  manufacturers  are  the  immediate 
buyers;  and  it  is  they  who  are  commonly  spoken  of,  in  the 
language  of  the  market,  as  the  "consumers"  of  cotton.  They 
are  often  in  a  position  in  which  they  must  buy  cotton.  They 
have  a  plant  which  must  be  run  if  it  is  to  earn  anything  at  all, 
and  a  force  of  workmen  which,  to  remain  efficient,  must  be  kept 
together.  Each  manufacturer  wishes  to  keep  his  plant  working 
at  full  capacity,  and  his  workmen  fully  employed ;  yet  with  a 
small  crop,  there  is  less  cotton  to  be  worked  up.  On  the  other 
hand,  the  extent  to  which  consumers  will  pay  at  a  higher  rate 
for  the  diminished  amount  of  cotton  cloth  is  an  uncertain 


152  VALUE  AND  EXCHANGE 

factor.  The  manufacturers  try  to  get  from  the  merchants 
and  dealers  to  whom  they  sell,  a  higher  price  for  cloth  corre- 
sponding to  the  higher  price  of  cotton.  Both  these  sets  of 
business  men  will  say  that  it  is  the  high  price  of  cotton  which 
causes  the  high  price  of  cloth.  Yet  the  reverse  is  at  bottom 
the  case;  only  because  the  cloth  can  be  sold  at  a  high  price 
does  the  raw  material  command  a  high  price.  How  close  the 
correspondence  in  price  will  be,  how  much  the  investments  and 
commitments  of  the  manufacturers  will  affect  the  situation, 
how  the  calculations  and  transactions  of  cotton  dealers  and 
speculators,  and  cloth  merchants  and  buyers,  will  act  on  prices 
at  any  one  date  and  through  the  season, — these  are  matters  on 
which  the  action  of  the  fundamental  economic  forces  is  slow 
and  uncertain.  There  are  analogous  complications  when  there 
is  a  very  abundant  cotton  crop.  Then  manufacturers  are  not 
prepared  to  work  up  an  unusual  supply  of  the  raw  material; 
merchants  and  retailers  are  not  certain  how  far  and  at  what 
prices  they  can  find  a  market  for  additional  quantities  of  cloth. 
Though  cotton  cloth  is  a  commodity  having  an  elastic  demand, 
raw  cotton,  despite  the  fact  that  demand  for  it  is  derived  from 
that  for  cloth,  may  show  from  season  to  season  fluctuations 
such  as  one  would  expect  in  a  commodity  for  which  the  demand 
is  inelastic. 

Other  kinds  of  capital  goods  are  to  be  used  for  durable  tools 
and  plant.  Such  are  iron,  copper,  timber,  brick,  stone.  In  the 
end,  the  demand  for  these  also  rests  on  the  utility  of  the  enjoy- 
able commodities  made  with  them ;  they  also  have  a  derived 
utility.  But  proximately  the  demand  for  them  is  from  persons 
who  wish  to  use  them  in  connection  with  new  investments. 
When  the  prospect  of  profit  is  good,  the  prices  of  these  things 
rise ;  when  the  prospects  are  bad,  their  prices  fall.  Hence  their 
prices  are  closely  connected  with  those  alternations  of  activity 
and  depression,  of  good  times  and  bad  times,  which  are  among 
the  most  puzzling  of  economic  phenomena.  It  is  true  that  their 
market  price  is  settled  by  the  amount  which  the  last  purchaser 
—  the  least  eager  of  the  buyers  —  is  willing  to  pay.  And  in 


MARKET  VALUE.    DEMAND  AND  SUPPLY        153 

the  end,  no  doubt,  what  that  purchaser  is  willing  to  pay  de- 
pends on  what  he  can  get  in  turn  for  the  consumable  goods  made 
with  the  aid  of  the  capital  goods.  But  the  chain  of  connection 
is  a  very  long  and  irregular  one,  and  the  market  price  is  uni- 
versally affected  by  current  expectations  as  to  investment 
activity.  It  would  be  absurd  to  apply  to  these  articles  any 
strict  principle  of  marginal  utility.  That  principle,  like  others 
in  economics,  works  out  its  results  only  in  the  long  run,  and  with 
all  sorts  of  qualifications  and  complications. 

§  6.  Retail  prices  might  be  expected  to  illustrate  most 
clearly  the  play  of  marginal  utility ;  for  here  enjoyable  goods  are 
sold  to  their  consumers,  and  the  utilities  from  them  are  nearest 
realization.  Yet  in  fact  retail  prices  seem  less  subject  to  the 
working  of  supply  and  demand  than  wholesale  prices. 

Retail  prices  are  governed  proximately  by  custom.  People 
pay  the  traditional  or  going  price.  Even  the  amounts  which 
they  purchase  appear  to  be  governed  by  custom ;  they  buy 
the  quantities  which  they  are  in  the  habit  of  consuming.  And 
the  retail  prices  which  establish  themselves  as  customary  seem 
to  be  governed  by  wholesale  prices.  The  retail  dealers  charge 
more  when  there  is  a  considerable  and  apparently  definitive 
rise  in  wholesale  prices;  and  competition  among  themselves 
causes  them  to  charge  less  when  there  is  a  considerable  and 
lasting  fall.  No  doubt,  the  accommodation  of  retail  to  whole- 
sale prices  is  slow.  When  wholesale  prices  rise,  shopkeepers 
hesitate  to  ask  more,  partly  because  each  one  fears  that  his 
rival  may  entice  a  customer  away  by  keeping  to  the  old  price  for 
a  while.  Conversely  when  wholesale  prices  fall,  no  shopkeeper 
willingly  gives  his  customer  the  benefit  of  the  change :  he  waits 
until  some  competitor  precipitates  it.  But  the  two  sets  of  prices 
in  the  end  move  together.  Though  retail  prices  are  governed 
proximately  by  custom,  they  seem  in  the  end  to  follow  whole- 
sale prices. 

But  all  this  is  in  appearance  only.  The  consumption  of  every 
commodity  is  affected  by  its  price.  A  rise  in  price  checks  pur- 
chasers, a  fall  hi  price  stimulates  them.  Though  it  would  appear 


154  VALUE  AND  EXCHANGE 

that  people  continue  to  buy  simply  what  they  are  used  to  buy- 
ing, this  is  true  only  of  buyers  who  are  above  the  margin,  — 
those  who  have  been  enjoying  a  consumer's  surplus.  There  are 
always  some  just  on  the  margin,  to  whom,  at  the  ruling  price,  the 
purchase  is  just  worth  while  and  who  cease  buying  when  the  price 
goes  up.  And  conversely,  when  price  falls,  there  are  always 
some  additional  purchases.  How  great  the  changes  in  consump- 
tion are  with  rising  or  falling  price,  depends  on  the  elasticity  of 
demand.  But  some  degree  of  sensitiveness  there  always  is. 
So  certain  is  this,  that  the  wholesale  dealers  reckon  on  it  in  ad- 
vance, and  at  once  accommodate  the  current  prices  in  the  whole- 
sale market.  It  is  they  who  usually  are  best  informed  regard- 
ing the  general  situation.  They  know  when  a  crop  is  short,  or 
a  new  source  of  supply  has  been  opened,  or  an  invention  is 
cheapening  production  and  increasing  the  amount  offered  in  the 
market.  It  is  they,  too,  who  can  best  observe  when  the  habits 
of  consumers  are  undergoing  change  and  so  are  affecting  the 
purchases  of  a  commodity.  In  case  of  an  increase  in  demand, 
any  one  retailer  may  indeed  notice  that  his  customers  are  buying 
more  than  before ;  but  this  may  seem  to  him  an  isolated  phenom- 
enon. He  simply  orders  more  from  his  wholesale  agent,  and 
expects  to  sell  more  at  the  old  price.  But  when  orders  from 
many  retail  dealers  thus  come  in  to  many  wholesalers,  the  market 
responds  and  price  goes  up.  The  retail  dealer  then  charges 
more  to  his  customers  because  he  has  paid  the  wholesaler  more 
for  his  goods;  the  real  influence  at  work  being  that  the  cus- 
tomers, taken  as  a  whole,  want  the  goods  more.  Here,  as  in 
all  the  phenomena  of  value  and  price,  the  stocks  held  by  dealers, 
whether  retail  or  wholesale,  have  an  effect  in  preventing  abrupt 
changes,  and  sometimes  obscure  and  delay  the  restoration  of  the 
equilibrium  of  supply  and  demand.  In  the  end,  however,  that 
equilibrium,  resting  on  the  demand  of  the  marginal  purchaser 
and  so  on  the  principle  of  marginal  utility,  settles  both  whole- 
sale and  retail  prices. 

In  the  earlier  stages  of  industrial  life,  and  even  in  many  coun- 
tries which  have  attained  a  comparatively  advanced  stage,  retail 


MARKET  VALUE.    DEMAND  AND  SUPPLY        155 

prices  are  fixed  by  a  direct  process  of  higgling  between  sellers  and 
buyers.  In  the  very  earliest  and  most  primitive  stages,  indeed, 
when  exchanges  are  few  and  sporadic,  higgling  plays  a  very  im- 
portant part.  There  is  then  nothing  in  the  nature  of  a  market 
price  or  customary  price ;  and  the  astuteness  of  the  bargainers, 
the  needs  and  whims  of  the  moment,  even  the  possibility  of 
physical  force,  affect  the  terms  of  exchange.  As  the  division 
of  labor  is  extended  farther,  and  continuous  exchange  and  sale 
develop,  something  like  a  market  price  establishes  itself.  That 
market  price  is  likely  soon  to  become  a  customary  price,  repre- 
senting roughly  an  equilibrium  of  current  demand  and  supply ; 
but,  though  customary,  it  is  likely  also  to  be  subject  to  bargaining, 
and  to  vary  more  or  less  from  the  customary  rate. 

In  the  highly  developed  countries  of  modern  times,  bargaining 
in  retail  dealings  has  been  almost  entirely  discarded.  The 
dealer  sets  a  price  at  which  he  will  sell,  and  at  that  price  the  pur- 
chaser may  take  the  article  or  leave  it.  The  tacit  understand- 
ing is  that  the  price  so  fixed  shall  be  the  current  or  market  price, 
and  that  it  shall  be  the  same  for  all  customers  at  the  shop.  The 
practise  of  fixed  prices  saves  a  vast  amount  of  time  and  friction. 
The  purchaser  need  not  be  on  the  watch  to  discover  what  other 
dealers  are  asking,  and  what  is  the  going  price ;  while,  if  he  is  not 
a  marginal  purchaser,  but  is  enjoying  some  consumer's  surplus, 
he  need  not  be  on  his  guard  lest  the  dealer  take  advantage  of 
his  potential  demand.  The  ease  of  everyday  purchases  and  the 
efficiency  of  labor  in  retail  operations  are  immensely  promoted. 
Retailing  on  a  large  scale,  conducive  as  it  is  to  economy  of 
labor,  would  be  impossible  without  the  practise  of  fixed  prices. 
In  many  parts  of  the  continent  of  Europe  it  has  not  been  fully 
adopted.  There  the  retail  dealer  still  asks,  not  the  price  which 
he  will  take  once  for  all,  but  a  price  which  he  hopes  to  get  from 
the  individual  purchaser,  and  which  he  is  prepared  to  lower 
if  the  purchaser  bargains  shrewdly.  The  result  is  friction,  waste 
of  time,  and  inefficiency. 

§  7.  The  current  market  rate  is  what  people  usually  have  in 
mind  when  they  speak  of  a  "fair"  price.  This  is  what  the 


156  VALUE  AND  EXCHANGE 

retail  dealer  is  expected  to  charge  as  his  fixed  sum.  If  he  asks 
a  higher  price  than  is  usually  asked  at  the  time  by  other 
dealers  for  the  same  thing,  —  still  more,  if  he  asks  a  higher 
price  from  one  purchaser  than  from  another,  —  he  is  said  to 
be  charging  unreasonably,  or  overreaching,  or  even  cheat- 
ing; and  he  is  likely  to  lose  his  custom.  There  is  often  a 
similar  attitude  in  regard  to  wholesale  prices.  Many  large 
dealings  in  the  wholesale  market  are  concluded,  in  the  great 
civilized  communities,  on  the  principle  of  fixed  prices.  A 
manufacturer  or  merchant  in  search  of  a  given  article  orders 
what  he  wants  from  an  agent  or  correspondent  of  established 
reputation,  with  the  understanding  that  a  fair  price  —  that  is, 
the  ruling  market  price  —  will  be  charged.  Here,  as  in  retail 
dealings,  confidence  in  honesty,  and  acceptance  of  prices  as  they 
stand,  conduce  to  the  easy  dispatch  of  business.  Underlying 
all,  however,  is  bargaining  somewhere,  —  a  more  or  less  overt 
adjustment  of  price  to  supply  and  demand.  What  is  a  fair 
price  in  the  fundamental  sense — what  is  the  really  just  price  at 
which  goods  shall  be  sold  —  are  questions  much  more  difficult 
than  is  supposed  by  most  persons  who  use  the  phrases.  In- 
deed, few  who  talk  of  fair  and  unfair  prices  are  conscious  of 
the  problems  involved.  But  they  are  problems  not  of  exchange, 
but  of  distribution,  and  therefore  taken  up  at  a  later  stage  of  the 
inquiry. 

§  8.  The  discussion  throughout  the  preceding  pages  has  pro- 
ceeded on  the  assumption  that  utility  to  the  buyer  is  the  only 
aspect  of  utility  that  needs  consideration.  The  seller  is  supposed 
to  put  his  wares  on  the  market  once  for  all,  and  to  dispose  of 
them,  sooner  or  later,  on  such  terms  as  their  utility  to  buyers 
makes  possible.  But  may  not  utility  to  sellers  also  affect  price, 
by  affecting  supply  ?  May  not  part  of  the  supply  be  withdrawn 
by  the  sellers,  for  their  own  use  ?  Would  not  the  extent  of  this 
withdrawal  depend  on  the  price,  and  so  introduce  a  further  com- 
plication in  the  theory  of  market  value  ? 

It  is  entirely  conceivable  that  utility  to  sellers  should  thus 
affect  price.  In  the  case  of  the  five  oranges,  supposed  above,  it 


MARKET  VALUE.    DEMAND  AND  SUPPLY        157 

is  conceivable  that  the  holder  of  them  might  consider  the  pos- 
sibility of  enjoying  one  himself,  and  would  be  led  to  do  so  more 
and  more  as  the  price  descended.  At  fifty  cents  he  would  readily 
part  with  one  of  his  oranges,  but  at  five  cents  he  might  conclude 
to  eat  one,  and  so  withdraw  part  of  the  supply.  And  if  we 
suppose,  not  one  seller  with  a  few  oranges,  but  many  sellers 
with  many  oranges,  and  suppose  that  among  these  sellers  there 
is  a  considerable  possibility  of  withdrawals  for  consumption, 
we  have  a  new  problem,  more  complicated  than  that  of  sales 
based  on  utility  to  buyers  only.  A  great  deal  of  intellectual 
ability  has  been  given  by  economic  writers  to  the  analysis  of 
this  problem,  and  to  the  careful  statement  of  the  terms  of  ex- 
change that  would  result  under  various  hypothetical  conditions. 

But  almost  all  this  subtle  analysis  is  in  the  air.  Under  a  de- 
veloped division  of  labor,  utility  to  sellers  does  not  affect  value. 
Men  produce  with  no  reference  to  their  own  consumption. 
They  produce  for  the  market.  The  supplies  in  their  hands  of 
the  things  made  by  them  are  so  great  that  the  importance  to 
them  of  any  unit  is  nil.  They  throw  their  product  on  the 
market  without  reserve.  No  doubt,  if  that  product  were  very 
great  indeed,  —  such  as  to  make  the  marginal  utility  to  pur- 
chasers almost  nil, — the  sellers  might  stop  to  consider  whether 
they  could  not  use  some  fraction  of  it  themselves.  Farmers  may 
consume  more  apples  when  a  very  heavy  crop  causes  apples 
(on  the  tree?)  to  be  nearly  valueless.  But  any  supply  created 
by  effort  and  with  a  view  to  sale  is  rarely  so  far  increased  that 
price  sinks  near  zero;  and  where  by  mischance  price  is  very 
greatly  lowered,  the  effect  of  utilization  by  the  makers  (sellers) 
is  so  slight  as  to  be  negligible.  Virtually  the  whole  supply  is,  in 
the  ordinary  case,  offered  once  for  all  on  the  market. 

The  case  would  be  different  if  supplies  got  into  people's  hands 
without  reference  from  the  start  to  sale  and  disposal.  If  they 
were  rained  down  from  heaven,  in  small  amounts,  price  would  be 
affected  by  utility  to  sellers  quite  as  much  as  by  utility  to  buyers. 
In  early  times,  before  division  of  labor  and  exchange  had  de- 
veloped far,  sporadic  exchanges  took  place,  we  may  imagine, 


158  VALUE  AND  EXCHANGE 

under  these  apparently  simple,  though  really  complex,  conditions. 
But  they  must  have  taken  place  either  with  very  vague  con- 
sciousness of  utility,  or  under  the  influence  of  customs  which 
greatly  affected  the  actual  terms  of  exchange.  Ingenious 
hedonistic  calculations  probably  throw  little  light  on  what  hap- 
pens in  the  stray  exchanges  of  barbarians. 

There  are,  however,  in  the  modern  world  occasional  cases 
where  exchange  is  affected  by  utility  to  sellers.  When  a  fine  old 
picture  or  a  family  heirloom  is  put  on  the  market,  its  price  may 
depend  much  on  the  attachment  which  the  owner  feels  for  it. 
Articles  of  this  sort,  of  sporadic  and  limited  supply,  are  in  any 
case  largely  indeterminate  in  value ;  since  buyers  are  few,  and 
demand  is  discontinuous.  Their  price  may  be  made  still  more 
indeterminate  by  the  fact  that  the  seller  (or  sellers)  may  set 
store  by  the  few  specimens.  The  same  is  true,  though  in  very  much 
less  degree,  of  dwellings  adapted  to  individual  tastes.  The  or- 
dinary house,  planned  like  many  others  of  its  class,  comes  on 
the  market  on  nearly  the  same  terms  as  other  goods  of  ho- 
mogeneous supply.  But  an  odd  house,  built  to  suit  the  owner's 
idiosjoicrasies  of  taste,  stands  more  or  less  by  itself.  Its  selling 
price  may  depend  not  only  on  the  going  price  for  houses  of  this 
range  of  desirability  as  estimated  in  the  general  market  (that 
is,  as  estimated  by  buyers),  but  also  on  the  attachment  which 
the  owner  has  for  this  -particular  one. 


CHAPTER  11 
SPECULATION 

§  1.  The  phenomena  of  speculation  connect  themselves  with 
the  settlement  of  market  prices.  Something  more  may  now  be 
said  on  the  good  and  ill  of  speculative  dealings. 

The  term  "speculation"  is  used  in  various  senses.  Often  it 
implies  the  buying  and  selling  of  things  by  a  person  whose  main 
business  in  life  is  different,  —  "dabbling"  in  the  market  by  "out- 
siders." But  as  often  it  implies  buying  and  selling  by  persons 
who  expect  to  make  their  living  or  their  fortune  by  dealing  in  one 
commodity  or  in  certain  sets  of  commodities,  —  persons  who  are 
"professional  speculators."  These  are  sometimes  distinguished 
again  from  "legitimate"  dealers,  —  the  wheat  merchant,  the 
cotton  factor,  —  who  buy  and  sell  a  commodity  year  in  and  year 
out,  and  are  permanent  middlemen  for  those  who  have  it  to  sell 
and  those  who  wish  to  buy  it.  Between  these  various  sorts  of 
persons  there  are  insensible  gradations.  All  their  operations 
have  their  effect  in  determining  market  price ;  and  all  are  more 
or  less  in  the  nature  of  speculative  dealings. 

The  fundamental  effect  of  speculation  is  to  promote  the 
establishment  of  the  equilibrium  of  supply  and  demand.  It 
tends  to  make  daily  market  prices  conform  to  the  seasonal 
market  price,  and  to  make  the  seasonal  market  price  such  that 
the  whole  seasonal  supply  is  disposed  of.  Those  who  are 
skillful  and  painstaking  in  estimating  the  seasonal  supply,  and 
are  shrewd  and  experienced  in  foreseeing  the  effect  of  a  given 
supply  on  price,  are  the  persons  who  are  likely  to  make  money 
in  speculation.  They  buy  when  others  offer  at  a  price  lower 
than  the  facts  of  the  market  warrant;  they  sell  when  others 
bid  a  price  higher  than  the  facts  warrant.  The  more  the  deal- 

159 


160  VALUE  AND  EXCHANGE 

ings  of  the  market  are  confined  to  buying  and  selling  between 
such  shrewd  and  experienced  dealers,  the  more  likely  is  it  that 
the  seasonal  price  will  be  quickly  and  smoothly  reached,  and  the 
less  will  be  the  fluctuations  in  price.  With  the  inevitable  un- 
certainties as  to  the  amounts  of  the  forthcoming  supplies  and 
the  conditions  of  consumption  and  demand,  there  will  always 
be  differences  of  judgment  between  even  the  most  expert  dealers. 
There  will  be  fluctuations  in  price,  some  ups  and  downs,  some 
unexpected  gains  and  losses,  —  " speculative'7  profits  or  losses. 
But  the  general  effect  of  speculation  is  to  lessen  fluctuations, 
and  promote  the  smooth  course  of  exchange  and  consumption. 

This  lessening  of  fluctuations  is  advantageous  alike  to  the 
ultimate  consumers,  and  to  those  manufacturers  who  in  busi- 
ness parlance  are  often  spoken  of  as  the  "consumers"  of  a  raw 
material.  For  the  ultimate  consumers,  say  of  wheat,  the  early 
and  exact  adjustment  of  price  brings  more  even  utilization  of 
the  available  supply.  If  the  crop  be  short,  some  lessening  of 
consumption  is  inevitable;  and  it  is  better  that  the  deficit  be 
spread  through  the  season.  The  sooner  and  the  more  exactly 
the  higher  price  is  reached,  the  more  likely  is  this  result.  Con- 
versely, a  large  crop  is  better  sold  at  a  low  price  throughout  the 
season  than  at  prices  ranging  from  high  to  low  as  the  season 
progresses. 

The  good  effect  of  speculation  in  this  direction  has  been 
illustrated  from  the  experiences  of  older  days,  when  wide  fluc- 
tuations in  the  price  of  food  were  common.  Under  modern 
conditions,  with  great  areas  of  supply  brought  into  competition 
by  railways  and  steamships,  abrupt  changes  in  the  supply  of 
most  foodstuffs  and  raw  materials  are  rare.  A  poor  crop  in 
one  country  or  section  is  likely  to  be  offset  by  a  good  crop 
elsewhere.  The  seasonal  supplies  do  indeed  change,  and  prices 
go  up  and  down  under  their  influence;  but  the  variations  are 
seldom  great.  But  under  such  conditions  as  existed  under  the 
limited  geographical  division  of  labor  before  the  eighteenth 
century,  great  fluctuations  were  common.  Then  the  area  from 
which  any  district  or  city  got  its  food  and  materials  was  strictly 


SPECULATION  161- 

limited.  A  crop  deficiency  meant  a  short  supply,  and  necessi- 
tated the  adjustment  of  consumption  to  that  short  supply. 
The  dealers  or  speculators  or  "forestallers"  who  secured  the 
supply  and  at  once  demanded  high  prices  for  it,  brought 
about  the  inevitable  adjustment,  and  caused  a  more  even 
utilization  of  the  stock  in  hand.  All  this  was  reasoned  out  by 
some  of  the  older  writers  on  economics,  and  led  them  to  a 
warm  defense  of  speculators  and  to  a  condemnation  of  laws 
aimed  against  speculation.  Very  likely  their  defense  of  specu- 
lation was  carried  too  far.  The  process  of  buying  from  the 
farmers  did  not  necessarily  take  place  under  active  competition 
by  the  dealers  or  speculators,  nor  did  that  of  selling  to  the 
consumers ;  and  the  gains  of  the  speculators  were  enhanced  by 
the  ignorance  or  heedlessness  of  both  farmers  and  consumers, 
and  might  easily  be  thought  larger  than  could  seem  reasonable. 
We  know  very  little  of  the  details  of  what  took  place  in  these 
early  days,  and  are  prone  to  project  into  them  ideas  or  con- 
clusions based  on  our  own  experiences.  But  none  the  less  it  is 
probable  that  even  in  those  times  the  influence  of  speculation 
was  in  the  main  to  lessen  fluctuations  and  promote  the  expedient 
rate  of  consumption.  It  is  certain  that  this  is  its  tendency 
under  the  modern  conditions  of  wide  markets,  full  information, 
active  competition. 

The  development  of  cold  storage  in  recent  times  has  led  to 
precisely  this  sort  of  evened  distribution  of  supply  under  the 
influence  of  dealings  that  are  essentially  speculative.  Fruit, 
meat,  fish,  eggs,  no  longer  come  on  the  market  in  spasmodic 
and  irregular  amounts.  Supplies  that  are  heavy  at  one  time 
are  bought  by  dealers,  put  in  storage,  and  held  for  sale  at  a 
later  period  of  scantier  supply.  Prices  are  more  equable,  and 
on  the  whole  the  profits  of  dealers  are  probably  less.  There  is 
less  risk  to  them,  and  the  community  gets  its  supplies  at  a 
smaller  charge  for  their  services  as  middlemen. 

§  2.  The  process  of  lessening  fluctuations  and  distributing 
risks  is  much  promoted  by  the  practise  of  dealing  in  "futures," 
• —  a  practise  with  which  the  term  "  speculation "  is  especially 


162  VALUE  AND  EXCHANGE 

associated.  Goods  are  bought  and  sold  not  only  for  imme- 
diate delivery,  but  for  future  delivery  as  well.  The  person  — 
say  the  dealer  —  who  undertakes  to  deliver  in  the  future  a 
certain  quantity  of  wheat  at  a  certain  price  may  not  have  in 
his  possession  the  goods  he  sells ;  indeed,  in  the  common  course 
of  such  dealings  in  the  modern  markets,  he  usually  does  not 
have  them.  He  gauges  the  probabilities  of  the  future,  and 
undertakes  delivery  on  the  terms  which  those  probabilities 
suggest.  Virtually,  he  guarantees  a  certain  price  for  the 
future,  and  takes  his  chances  as  to  whether  the  guarantee  will 
bring  him  gain  or  loss.  The  buyer  is  then  relieved  of  the  risk. 
The  advantage  of  this  security  is  easily  seen.  The  miller,  for 
example,  may  wish  to  close  a  contract  for  the  sale  of  flour  in 
the  future.  By  securing  the  needed  wheat  at  a  guaranteed 
price,  he  is  freed  from  all  the  risk  of  ups  and  downs,  and  can 
give  his  undivided  attention  to  his  proper  business  of  manufac- 
turing flour.1 

Hence  it  has  happened,  since  the  establishment  of  exchanges 
and  the  development  of  their  varied  operations,  that  millers 
carry  on  their  business  with  a  much  smaller  margin  of  profit 
than  formerly.  The  difference  in  price,  weight  for  weight, 
between  wheat  and  flour,  is  much  less  than  it  was  thirty  or  forty 
years  ago,  and  the  public  gains  in  so  far.  When,  for  example, 
the  flour-milling  industry  was  first  established  at  Minneapolis, 
— -where  the  falls  of  the  Mississippi  supplied  power  for  grind- 
ing the  wheat  of  a  region  singularly  adapted  to  its  growth,  — 
the  possibility  of  profit  for  the  miller  was  great.  But  he  then 
underwent  also  the  chances  of  loss  from  fluctuation  in  the 
price  of  wheat.  As  the  exchanges  developed,  and  with  them 

1  Even  if  he  is  not  contracting  for  the  future  sale  of  flour  at  a  given  price,  but 
is  simply  manufacturing  continuously  for  the  market,  he  can  escape  by  this  same 
mechanism  from  the  risk  of  fluctuations  in  the  price  of  wheat.  When  he  buys 
a  given  quantity  of  wheat  to  be  ground  into  flour,  he  can  sell  for  future  delivery 
the  same  quantity  of  wheat.  Thereafter,  as  wheat  goes  up  or  down,  he  loses 
as  much  by  the  one  of  these  transactions  as  he  gains  by  the  other.  The  fluctua- 
tions no  longer  trouble  him.  This  is  the  common  practise  among  "conserva- 
tive" millers.  Cotton  manufacturers  also  are  getting  more  and  more  into 
the  practise  of  thus  "hedging"  in  their  purchases  of  raw  cotton. 


SPECULATION  163 

the  practise  of  dealing  for  future  delivery,  he  was  able  to  free 
himself  from  these  chances.  The  consequent  regularity  and 
solidity  of  the  industry  contributed  to  its  systematic  develop- 
ment on  a  great  scale,  and  so  to  the  cheapening  of  flour.  Inven- 
tions and  improvements,  no  doubt,  contributed  greatly ;  but  the 
elimination  of  market  risks  had  an  important  share  in  reducing 
the  difference  between  the  price  of  wheat  and  the  price  of 
flour.  Both  in  merchandizing  and  in  manufacturing,  the 
growth  of  large-scale  transactions,  though  it  has  increased  the 
gains  of  those  individuals  who  have  the  ability  to  carry  on 
large  operations,  has  lessened  the  margin  between  buying 
price  and  selling  price,  and  so  has  operated  to  lower  prices  for 
the  consuming  public. 

The  dealer  or  speculator  who  has  sold  for  future  delivery  does 
not  usually  run  all  the  risks  of  the  transaction  himself.  He  is 
likely  before  long  to  buy  from  another  dealer,  for  future  delivery, 
some  part  of  what  he  has  contracted  to  deliver,  perhaps  the 
whole ;  that  other  dealer,  in  turn,  shifts  part  of  the  business  to  a 
third;  and  so  on.  The  process  of  gauging  the  course  of  the 
market  fluctuations  is  hardly  ever  carried  through  the  whole 
of  a  season  by  one  person  for  any  one  transaction.  The  dealers 
constantly  buy  and  sell  among  themselves,  and  divide  risks  and 
profits  and  losses.  It  is  extremely  rare,  consequently,  that  any 
one  dealer  or  any  one  person  buys  at  the  lowest  price  of  a 
season  and  sells  at  the  highest  price,  making  the  utmost  possible 
gain;  or  that  any  one  buys  at  the  highest  and  sells  at  the 
lowest  price,  incurring  the  maximum  loss.  Every  dealer  has 
losses  as  well  as  gains.  On  the  whole,  if  he  is  shrewd  and 
experienced,  he  gains  more  than  he  loses.  He  may  lose  money 
in  one  season,  but  he  will  make  money  in  another,  and  in  the 
long  run  he  will  earn  something  in  the  nature  of  a  professional 
income.  If  he  is  gifted  with  unusual  ability  for  such  operations, 
he  may  make  gains  almost  invariably,  reap  great  profits  from 
large  transactions,  and  close  his  career  with  a  fortune. 

§  3.  When  commodities  are  produced  on  a  large  scale  for 
distant  markets  and  for  scattered  purchasers,  and  middlemen 


164  VALUE  AND  EXCHANGE 

become  necessary  links  in  the  division  of  labor,  it  is  inevitable 
that  the  middlemen  should  arrange  to  be  near  each  other  for 
the  convenient  disposal  of  their  business.  A  street  corner  may 
serve  as  a  meeting  place.  Traders  in  one  commodity  will 
settle  near  each  other  in  a  given  street;  hence  in  every  great 
city  there  are  dry  goods  streets,  hardware  streets,  boot  and  shoe 
and  leather  streets,  and  so  on.  When,  in  a  populous  and 
thriving  country,  commodities  are  produced  in  large  quantities 
and  are  necessarily  dealt  in  by  many  persons,  an  exchange  is 
set  up,  —  a  room  or  building  where  the  traders  meet  at  fixed 
hours.  Rules  are  agreed  on,  governing  and  interpreting  their 
transactions  in  such  detail  that  enormous  sales  are  effected  by 
a  nod  of  the  head,  and  are  recorded  on  scraps  of  paper  with  a 
few  figures  and  initials.  The  actual  dealings  on  exchanges  are 
often  done  by  brokers  only,  who  are  middlemen  for  the  middle- 
men. They  act  simply  as  agents,  earn  their  living  by  a  com- 
mission (usually  an  extraordinarily  small  one)  on  sales  and 
purchases,  and  buy  or  sell  for  any  one  who  chooses  to  transact 
business  through  them. 

The  smooth  dispatch  of  business  on  exchanges  is  further 
assisted  by  the  "standardizing"  of  the  articles  dealt  in;  that 
is,  by  grading  and  classifying  them  according  to  quality.  This 
process  puts  an  end  to  all  disputes  regarding  the  quality  of 
the  things  contracted  for.  Thus  grain  is  examined,  as  it  reaches 
the  Chicago  market,  by  publicly  appointed  inspectors,  and  is 
graded  as  being  No.  1,  No.  2,  No.  3.  Thereafter,  when  a  pur- 
chaser has  his  wheat  delivered  to  him,  neither  he  nor  his  vendor 
need  inquire  further  whether  it  is  of  the  stipulated  quality. 
Delivery  of  elevator  receipts,  certifying  the  grade,  satisfies  all 
contracts.  Any  article  that  is  homogeneous  in  quality,  or  is 
easily  classified  into  distinct  grades,  can  thus  be  dealt  in  with 
the  minimum  of  friction.  Grain  is  the  typical  commodity  of 
this  sort.  Cotton  is  similar  to  it,  through  its  evenness  of  quality. 
Wool,  which  varies  remarkably,  is  much  less  susceptible  of 
rapid  speculative  purchase  and  sale.  Attempts  have  been 
made  to  standardize  iron,  and  in  England  a  system  of  semi- 


SPECULATION  165 

official  grading  exists  under  which  large  transactions  in  it  are 
carried  on;  but  in  the  United  States  and  on  the  Continent 
this  mode  of  dealing  in  iron  has  never  come  into  considerable 
use. 

§  4.  Against  the  advantages  which  professional  speculative 
dealings  bring  are  to  be  set  serious  evils.  These  evils  are  made 
possible  and  are  enhanced  by  the  very  facilities  which  enable 
speculation  to  work  out  its  good  effects. 

When  once  a  commodity  has  been  standardized,  a  new 
possibility  opens  ;  anybody  and  everybody  can  deal  in  it. 
Ordinarily,  he  who  buys  an  article  must  know  something  about 
it.  He  must  be  able  to  judge  whether  what  is  offered  to  him 
is  good  or  bad  in  quality,  worth  more  or  less.  But  on  an  ex- 
change where  commodities  are  officially  graded,  no  such  ques- 
tions arise.  Only  price,  present  and  future,  need  be  con- 
sidered. Any  one  can  buy  if  he  thinks  the  present  price  low, 
or  sell  if  he  thinks  it  high.  Such  buying  and  selling  are  done, 
on  an  enormous  scale,  by  large  numbers  of  persons  who  do  not 
possess  or  wish  to  possess  the  articles  they  buy  or  sell,  and 
whose  only  concern  is  to  make  a  profit  by  taking  advantage 
of  fluctuations  in  prices.  They  virtually  bet  on  the  future 
price  of  the  commodities,  and  gamble  about  it  as  men  gamble 
on  cards  or  on  horse  races.  In  form,  their  dealings  are  like 
any  others  on  the  exchange.  The  brokers  receive  from  these 
"outsiders"  orders  to  buy  and  sell,  and  by  the  rules  of  the 
exchange  are  held  responsible  for  delivery  at  the  stipulated 
time.  The  brokers,  in  turn,  hold  their  customers  to  this  same 
responsibility.  But,  though  thus  in  form  like  any  other  dealings, 
on  the  better-known  exchanges,  —  the  cotton  and  grain  ex- 
changes, for  example,  —  the  immense  majority  of  the  trans- 
actions have  in  view  no  bona  fide  business.  The  machinery 
which  has  been  devised  for  the  easy  and  rapid  transaction  of 
business  is  utilized  for  gambling  on  a  large  scale. 

Here  we  have  an  example  of  unproductive  labor.  Of  course, 
dealers,  middlemen,  brokers,  are  useful,  and  their  labor  is  pro- 
ductive, so  far  as  they  serve  to  facilitate  exchanges  under  an 


166  VALUE  AND  EXCHANGE 

elaborate  division  of  labor.  Just  how  much  labor  can  be  use- 
fully given  to  this  sort  of  work,  it  would  be  difficult  to  say. 
If  the  only  persons  engaged  in  the  transactions  were  merchants 
and  dealers  who  systematically  and  continuously  gave  their  time 
and  effort  to  it,  their  number  would  adjust  itself  automatically 
to  the  work  required,  —  much  as  the  number  of  carpenters  or 
physicians  adjusts  itself  to  actual  needs.  But  where  there  is 
"illegitimate"  speculation  on  a  great  scale,  the  number  of 
brokers  and  dealers  accommodates  itself  to  this  new  demand 
for  their  services.  Not  only  the  labor  of  the  speculators,  but 
that  of  their  agents,  is  unproductive;  it  adds  nothing  to  the 
output  of  society.  In  no  country  is  there  so  much  of  this 
parasitic  activity  as  in  the  United  States,  for  here  all  the  con- 
ditions favorable  to  it  are  found,  —  a  highly  developed  division 
of  labor,  markets  and  exchanges  on  a  great  scale,  and  a  popu- 
lation both  venturesome  and  prosperous.  "Business"  to  many 
an  American  means  simply  speculative  gambling. 

Unquestionably,  the  "outside"  speculators,  or  the  "public," 
are,  like  all  amateur  gamblers,  losers  as  a  class;  and  most  of 
them  are  in  the  long  run  losers  individually.  The  shrewd  and 
experienced  professional  dealers  know  better  than  they  the 
probable  course  of  prices,  sell  to  them  and  buy  from  them  to 
advantage,  and  on  the  whole  make  money  from  them.  Occa- 
sionally an  able  or  lucky  person  makes  a  hit,  and  carries  off  a 
large  share  of  plunder  from  a  successful  operation  on  the  ex- 
change. This  then  acts  on  the  imagination  of  others  like  a 
great  prize  won  in  a  lottery.  The  chances  that  the  speculative 
public  will  lose  are  almost  as  great  as  the  chances  that  the 
purchasers  of  lottery  tickets  as  a  whole  will  lose  :  they  amount 
almost  to  a  certainty. 

Unmistakable  as  are  the  evils  of  speculative  gambling,  it  is 
exceedingly  difficult  to  check  them  by  legislation,  still  more 
to  put  an  end  to  them.  The  common  law  already  makes  void 
transactions  which  are  sales  in  form  merely,  and  which  con- 
template a  settlement  only  of  the  difference  between  present 
and  future  price.  But  on  the  exchanges  all  transactions  pur- 


SPECULATION  167 

port  to  be,  and  in  strict  legal  effect  are,  for  the  actual  delivery 
of  the  commodities.  An  obvious  remedial  measure  is  to  pro- 
hibit buying  and  selling  for  future  delivery,  since  it  is  in  con- 
nection with  such  contracts  that  the  gambling  operations  most 
often  take  place.  But  this  would  put  an  end,  also,  to  the  benefits 
which  the  community  gets  from  contracts  for  futures;  and  it 
is  a  question  whether  the  loss  would  not  outweigh  the  gain. 
The  common  opinion  of  American  and  English  economists  is 
against  the  prohibition  of  future  contracts,  which,  so  far  as 
grain  is  concerned,  has  been  put  into  effect  in  Germany.  Yet  the 
evils  of  speculative  gambling  are  so  great  that  something  may 
be  risked  for  the  purpose  of  lessening  them.  Lotteries  and 
avowed  gambling  houses  have  been  prohibited,  and  the  law 
does  its  utmost  to  prevent  wholesale  betting  on  horse  races; 
and  all  it  can  do  to  stamp  out  other  forms  of  gambling  is  wel- 
come. No  doubt,  the  most  effective  remedy  would  be  a  better 
moral  standard  for  all  industry,  and  an  aroused  public  opinion 
against  all  kinds  of  gambling.  But  the  worship  of  wealth, 
and  the  well-nigh  universal  desire  to  make  money  on  easy 
terms,  even  though  at  the  expense  of  others,  together  with  the  close 
association  of  this  sort  of  speculation  with  business  dealing 
rightly  deemed  legitimate,  render  it  difficult  to  bring  public 
opinion  to  bear. 

§  5.  What  has  been  said  in  the  preceding  sections  applies  in 
the  main  to  stock  exchange  speculation  also ;  but  the  problems 
appear  here  in  accentuated  form.  Here,  too,  advantages  are  to  be 
set  against  evils.  The  advantages,  it  is  true,  are  of  a  different 
sort  from  those  secured  by  grain  and  cotton  exchanges.  They 
arise,  not  from  the  lessening  of  fluctuations  or  the  facilitation  of 
large-scale  dealings,  but  from  the  promotion  of  investment.1 
They  are  real  and  important.  But  the  evils  are  no  less  real, 
and  are  intensified  by  the  unusual  ease  of  entering  on  the  trans- 
actions. Stock  exchange  securities  are  ideally  homogeneous  and 
standardized.  One  share  of  a  given  corporation's  stock  is  pre- 
cisely as  good  as  any  other  share.  If  it  is  easy  for  any  one  to  buy 

i  See  Book  I,  Chapter  6. 


168  VALUE  AND  EXCHANGE 

grain  or  cotton,  even  though  he  has  never  looked  at  the  articles, 
it  is  still  easier  for  any  one  to  buy  stocks  and  bonds,  even  though 
he  knows  nothing  about  the  corporation  that  issues  them.  At  the 
same  time,  fluctuations  in  the  prices  of  securities  are  large  and 
frequent.  Opinion  regarding  their  probable  course  depends  (or 
seems  to  depend)  quite  as  much  on  general  judgment  and  general 
prospects  as  on  expert  information.  Hence  rampant  speculation, 
by  outsiders  and  insiders.  Here,  as  in  the  case  of  commodity 
speculation,  the  "public"  loses  in  the  immense  majority  of  trans- 
actions. The  professional  speculators  and  dealers  get  the  ad- 
vantage of  the  miscellaneous  public,  both  because  they  are  better 
informed  regarding  the  real  prospects  of  the  enterprises  whose 
securities  are  dealt  in,  and  because  they  are  (by  a  process  of 
quasi-natural  selection)  persons  shrewd  in  judging  human  nature 
and  quick  to  take  advantage  of  the  irresolute.  Yet  notwith- 
standing the  constant  losses,  there  is  an  unfailing  stream  of  per- 
sons who  take  fliers  on  the  stock  exchanges.  There  are  probably 
few  Americans  of  the  well-to-do  classes  who  have  not  at  one  time 
or  another  tried  their  hands  at  a  stock  speculation ;  and  there 
are  a  great  many  who  habitually  gamble  in  stocks.  The  im- 
mense majority  of  these  dealings  are  concentrated  at'  the  New 
York  Stock  Exchange,  which  is  at  once  the  greatest  institution 
in  the  world  for  facilitating  investment  and  the  greatest  of 
gambling  hells. 

The  evil  from  the  situation  arises  not  only  or  chiefly  from  the 
losses  of  the  unsuccessful  speculators.  What  these  lose,  others 
gain,  and  usually  there  is  not  much  to  choose  between  winners 
and  losers.  The  economic  loss  arises  primarily  from  the  waste 
of  much  brains  and  energy  on  unproductive  doings.  The  waste 
is  more  than  that  of  the  labor  given  directly,  —  the  labor  of 
the  brokers  and  their  under-strappers,  and  of  the  speculators 
themselves.  It  is  increased  by  the  demoralization  of  many 
men  in  the  community  who  take  no  great  direct  share  in 
speculation.  Like  all  gambling,  it  distracts  from  the  sober, 
continuous  work  on  which  the  common  welfare  rests.  Morally, 
it  is  no  less  harmful.  In  every  aspect  the  evil  is  one  of  the 
greatest  in  contemporary  society. 


SPECULATION  169 

It  must  be  frankly  confessed  that  no  really  promising  remedies 
have  been  suggested.  Some  excrescences  have  been  aimed  at  in 
recent  proposals  for  reform  in  New  York  —  proposals  which 
look  to  improvement  through  the  revision  and  enforcement  of 
the  rules  made  by  the  exchanges  for  themselves.  Such  things 
as  rigging  of  the  market,  "wash  sales,"  manipulation  of  prices 
with  intent  to  deceive,  are  to  be  thus  prevented.  But  even  if  all 
of  these  tricks  were  cut  out,  the  main  evil  would  remain.  In 
Germany  a  more  drastic  remedy  has  been  tried,  —  the  require- 
ment of  publicity  in  stock  dealings,  through  enrollment  of  names 
and  transactions  on  a  register  open  to  general  inspection.  It  is 
expected  that  men  will  refrain  from  stock  gambling,  as  they 
will  from  many  doings  of  doubtful  aspect,  if  they  must  be  seen 
in  the  act.  Such  a  requirement  would  be  met  in  the  United 
States  by  the  objection  that  it  intrudes  on  the  sacrosanct 
secrecy  of  business,  an  objection  commonly  brought  against 
public  supervision  of  every  sort,  yet  in  itself  of  little  weight. 
Much  more  serious  is  the  objection  that  in  Germany  the  regu- 
lation has  in  fact  had  little  effect :  stock  speculation  has  re- 
mained much  the  same  in  character  and  amount.  Possibly  this 
is  because  of  the  difficulty  of  effective  enforcement.  At  all 
events,  though  the  evil  is  there,  no  clear  remedy  of  a  direct  sort  is 
in  sight.  Greater  regularity  of  all  industry  would  lessen  fluctu- 
ation in  values,  and  so  lessen  speculation ;  but  this  would  be  at 
the  cost  of  progress.  Better  public  opinion  would  lessen  "  out- 
side "  speculation ;  but  the  enlightenment  of  public  opinion  pro- 
ceeds very  slowly. 


CHAPTER  12 

VALUE  UNDER  CONSTANT  COST 

§  1.  In  the  preceding  chapter,  the  adjustment  of  value  was 
considered  under  the  supposition  that  supply  was  fixed ;  fixed, 
not  indeed  for  the  day  or  the  week,  nor  rigidly  over  any  length  of 
time,  but  fixed  on  the  whole  for  the  season  or  the  period  of  pro- 
duction. But  even  for  the  agricultural  commodities  whose  pro- 
duction is  seasonal,  there  is  variation  in  supply  over  a  series  of 
seasons.  For  other  commodities  there  is  clearly  a  considerable 
and  sometimes  rapid  flexibility  in  supply.  The  amount  pro- 
duced and  put  on  the  market  changes  more  or  less  easily.  In 
what  way  do  the  variations  in  supply  take  place,  and  in  what 
way  do  they  affect  the  value  of  commodities  ? 

We  may  begin  by  taking  the  simplest  case,  and,  for  the  purpose 
of  bringing  into  sharp  relief  a  principle,  make  again  an  extreme 
supposition.  In  the  preceding  discussion  of  demand  and  supply 
and  of  market  value,  an  absolutely  fixed  supply  was  assumed  at 
the  outset.  Let  now  the  other  extreme  be  assumed,  a  supply 
absolutely  flexible.  Suppose  a  commodity  produced,  under  the 
simplest  conditions,  by  a  large  number  of  persons.  Suppose 
that  all  these  persons  are  competing  with  each  other ;  that  any 
one  of  them  can  easily  engage  in  producing  the  commodity,  and 
as  easily  withdraw  from  producing  it.  Suppose  all  to  be  carry- 
ing on  operations  under  the  same  conditions,  no  one  of  them 
producing  more  cheaply  than  another.  Such  a  commodity 
would  be  brought  to  market  under  conditions  of  constant  cost, 
and  would  be  sold  at  a  price  conforming  to  that  cost.  At  any 
moment  its  value  would  indeed  be  determined  directly  by  its 
quantity,  —  that  is,  by  marginal  utility  as  analyzed  in  the  last 
three  chapters.  But  if  its  value,  so  determined,  were  greater 

170 


VALUE  UNDER  CONSTANT  COST  171 

than  its  cost,  more  persons  would  be  led  to  engage  in  its  pro- 
duction, supply  would  increase,  and  value  would  fall.  If  its 
value  at  any  time  were  less  than  its  cost,  some  persons  would 
.withdraw  from  its  production,  supply  would  decrease,  and  value 
would  rise.  The  greater  the  ease  of  entering  on  the  industry 
and  of  withdrawing  from  it,  the  more  rapid  and  certain  would  be 
the  adjustment  of  supply  to  that  amount  which  would  just  sell  at 
cost  price.  If  perfect  flexibility  in  supply  be  assumed,  the  ad- 
justment of  value  to  cost  would  be  perfect,  and  the  article  would 
always  sell  for  just  what  it  cost  to  produce  it. 

Before  proceeding  further,  a  word  of  explanation,  and  in  some 
ways  of  warning,  is  needed,  as  to  the  sense  in  which  cost  of  pro- 
duction is  here  spoken  of.  The  term  is  used  in  very  nearly  the 
ordinary  commercial  sense;  it  refers  to  the  outlays  which  an 
employing  capitalist  must  make  in  order  to  get  a  commodity  to 
market.  Chief  among  those  is  the  outlay  for  the  wages. 
Charges  for  material  are  another  item.  These  charges,  it  is 
true,  commonly  imply  that  another  capitalist  has  previously  paid 
laborers  to  make  the  materials,  which  then  have  been  sold  to  the 
particular  employer  in  question ;  hence  the  latter  may  be  said 
to  have  indirectly  hired  these  other  laborers  also.  Not  only 
the  wages  paid  to  workmen,  directly  or  indirectly,  must  be  in- 
cluded, but  a  reasonable  remuneration  for  the  employer's  own 
time  and  trouble.  This  remuneration,  like  that  of  the  workmen 
employed,  is  to  be  reckoned  according  to  current  market  stand- 
ards, —  what  a  workman  or  an  employer  of  this  kind  would 
ordinarily  receive  for  his  labor.  Again,  interest  on  the  capital 
used  is  to  be  included,  reckoned  also  according  to  the  current 
market  rate.  If  the  employer  borrows  the  capital,  he  must  pay 
the  current  rate  of  interest  on  it.  If  he  owns  his  capital,  he  con- 
siders that  he  could  get  a  return  on  it  at  that  rate  by  lending  it 
out  to  some  one  else ;  and  he  regards  interest  on  his  own  capital 
precisely  as  he  regards  remuneration  for  his  own  labor, — some- 
thing for  which  a  return  at  the  usual  rate  is  to  be  expected.  It 
will  be  noticed  that  rent  paid  for  land  is  not  included  in  this  enu- 
meration, although  a  business  man  would  include  it  in  his  reckoning 


172  VALUE  AND  EXCHANGE 

of  cost.  The  reasons  for  this,  omission  will  be  made  plain  when 
the  subject  of  rent  comes  up  for  consideration. 

These  various  outlays,  or  equivalents  of  outlay,  are  sometimes 
spoken  of  as  "expenses  of  production."  When  that  term  is  used 
and  is  distinguished  from  "cost  of  production,"  emphasis  is  laid 
on  the  fact  that  the  employing  capitalist  is  concerned  solely 
with  what  he  pays  for  labor,  for  materials,  for  the  use  of  free  or 
fixed  capital.  When,  on  the  other  hand,  the  term  cost  of  pro- 
duction is  used  so  as  to  imply  a  distinction  from  expenses  of 
production,  reference  is  made  to  the  sacrifices  undergone ;  to 
the  labor  of  the  hired  workman,  and  not  to  his  wages ;  to  the 
trouble,  anxiety,  and  work  of  superintendence  of  the  employer, 
not  to  his  profits  or  ordinary  gains ;  to  the  previous  saving  by 
which  the  capital  has  been  accumulated,  not  to  the  interest  on 
that  capital.  As  will  be  seen  at  a  later  stage,  some  of  the  most 
important  and  difficult  problems  of  economics  connect  themselves 
with  the  distinction  between  cost  of  production  in  the  sense  of 
labor  and  sacrifice,  and  expenses  of  production  in  the  sense 
of  outlays.1  For  the  present,  however,  we  need  not  do  more 
than  point  out  the  distinction,  in  order  to  make  clear  in 
what  sense  we  are  speaking  of  cost.  We  mean  by  it  outlays  of  a 
capitalist.  If  we  should  think  of  a  workman,  or  set  of  workmen, 
producing  independently  and  without  being  hired  by  employers, 
we  should  reckon  cost  of  production  for  them,  not  in  terms  of 
hours  or  days  of  work  (i.e.  sacrifice),  but  in  terms  of  the  wages 
they  would  ordinarily  get  for  their  work. 

§  2.  The  mode  in  which  value  would  be  adjusted  under  the 
conditions  of  constant  cost  and  absolutely  flexible  supply  is  in- 
dicated on  Figure  5.  The  cost  of  the  commodity  is  indicated  by 
SO,  the  distance  from  the  horizontal  axis  OX  to  the  line  SS'. 
Whatever  the  amount  of  the  commodity  produced,  that  cost 
remains  the  same  for  each  unit  brought  to  market ;  whether  the 
quantity  be  OA,  OB,  OC,  the  cost  per  unit  is  the  same.  Hence 
SSf,  indicating  the  conditions  of  supply,  runs  parallel  to  OX. 
Let  the  line  DD'  indicate  the  conditions  of  demand,  as  in  pre- 

1  $ee  Book  V,  Chapter  48. 


VALUE  UNDER  CONSTANT  COST 


173 


vious  diagrams.  It  descends  as  quantity  becomes  greater,  price 
falling  with  the  increase  in  supply  and  the  consequent  lessening 
of  marginal  utility.  The  supply  of  the  commodity  would  then 
settle  at  the  amount  OB  or  SB'.  The  demand  and  supply  lines 


would  intersect  at  the  point  B' ;  there  would  be  equilibrium  at 
the  quantity  OB  and  the  price  BB'  (=  SO) .  If  the  supply  should 
dimmish  to  OA,  the  price  might  rise  temporarily  to  A  A',  A' 
being  the  point  at  which  the  supply  OA  intersects  the  demand 
lines.  The  marginal  utility  of  the  diminished  supply  would  be 
raised  to  A  A' ;  the  smaller  supply  (OA)  would  sell  at  a  higher 
price.  But  that  higher  price  would  lead,  under  the  conditions 
of  constant  cost,  to  a  prompt  increase  in  supply.  Producers 
would  be  getting  more  than  sufficed  to  induce  them  to  bring  the 
commodity  to  market.  They  would  compete  with  each  other, 
increase  supply,  and  so  bring  down  price.  If  the  supply  should 
be  increased,  not  only  to  B,  but  to  C,  the  total  being  then  OC, 
they  would  overreach  themselves.  For  the  amount  OC,  the 
price  would  be  CC',  the  point  of  intersection  with  the  demand 
line  being  then  C'.  This  sum  (CC')  is  less  than  cost;  some 


174  .      VALUE  AND  EXCHANGE 

producers  would  promptly  withdraw ;  supply  would  again  dimm- 
ish. For  the  quantity  OB,  the  price  is  just  sufficient  to  make 
production  worth  while  to  all,  and  at  that  amount  the  supply 
would  settle. 

If  now  for  any  reason  demand  should  increase,  quantity 
would  so  increase  as  still  to  leave  price  at  the  same  point.  Sup- 
pose a  change  in  fashion,  or  other  cause  leading  to  an  increased 
demand.  This  is  represented  by  a  shifting  of  the  demand  line 
to  the  right.  It  is  now  ddf,  whereas  before  it  was  DD' ;  at  each 
several  price,  more  of  the  commodity  is  demanded  than  was 
demanded  before  at  that  price,  and  the  marginal  utility  of  any 
given  supply  is  greater  than  it  was  before.  With  the  supply  OB, 
the  price,  under  these  new  conditions  of  demand,  would  be  not 
BB',  but  BB'd,  —  higher  than  cost.  Supply  would  again  in- 
crease, until  the  total  supply  was  OX.  Then  the  demand  line 
would  be  intersected  at  the  point  E  and  price  would  be  XE  = 
BB'.  A  new  equilibrium  would  be  established,  not  with  a 
change  in  price,  but  with  a  change  in  quantity  supplied. 

Under  the  conditions  of  constant  cost  and  free  competition, 
demand  or  marginal  utility  determines  not  price ,  but  quantity 
supplied.  The  proximate  condition  determining  value  is  in- 
deed always  marginal  utility.  Where  supply  is  fixed,  price  is 
settled  once  for  all  by  marginal  utility.  But  where  cost  is  con- 
stant and  supply  is  completely  flexible,  price  cannot  depart 
far  from  the  level  fixed  by  cost.  The  supply  on  the  market  will 
be  such  as  can  be  disposed  of  at  the  cost  price. 

§  3.  The  assumptions  made  at  the  beginning  of  this  chapter — 
constant  cost,  flexible  supply,  free  competition  —  are  never,  in  a 
literal  sense,  in  conformity  with  the  facts  of  industry.  There 
never  is  a  case  when  these  conditions  are  exactly  fulfilled.  None 
the  less,  there  is  a  wide  range  of  industry  in  which  an  approxima- 
tion toward  their  fulfillment  is  found,  and  in  which  the  principle 
of  value  under  constant  cost  explains  the  broad  facts. 

Cost  is  never  exactly  equal  for  all  producers.  In  this  chapter, 
constant  cost  has  been  spoken  of ;  but  it  is  not  material  whether 
we  speak  of  constant  or  of  equal  cost,  if  changes  in  the  general 


VALUE  UNDER  CONSTANT  COST  175 

level  take  place  simultaneously  for  all  the  producers.  An 
invention  or  improvement  may  lower  cost  for  all ;  the  hori- 
zontal supply  line  on  the  diagram  may  be  lowered;  but  the 
result  is  merely  adjustment  to  a  new  level,  not  the  introduction 
of  a  new  set  of  conditions.  If,  however,  the  lowering  of  cost  takes 
place  not  at  the  same  time  for  all  the  producers,  nor  in  equal 
degrees,  we  have  a  new  principle  and  a  different  case,  — production 
at  varying  cost.  This  is  what  in  fact  happens  when  inventions 
bring  about  a  reduction  in  cost.  The  change  takes  place  by  suc- 
cessive steps.  The  more  shrewd  and  enterprising  of  the  com- 
petitors introduce  the  improvements  first ;  others  follow  suit ; 
gradually  all  adopt  it.  And  by  the  time  all  have  adopted  one 
improvement,  another  may  be  introduced,  and  the  same  steps 
are  again  gone  through.  If  there  be  a  succession  of  changes,  — 
and  such  are  likely  in  the  highly  progressive  modern  industries,  — 
equality  of  cost  never  exists.  There  are  always  some  producers 
who  are  turning  out  their  goods  at  lower  cost  than  others. 

None  the  less,  there  is,  over  probably  the  greater  part  of  the 
industrial  field,  a  tendency  to  equality  of  cost.  The  differences 
in  cost  are  not  permanent ;  the  process  is  simply  one  of  gradual 
and  irregular  adjustment  to  the  new  level,  instead  of  prompt 
and  even  adjustment. 

Some  writers  have  stated  the  difference  between  actual  con- 
ditions and  long-run  tendencies,  by  distinguishing  between  a 
static  and  a  dynamic  state.  In  a  static  state  competition  has 
worked  out  its  full  result,  and,  unless  there  are  permanent  causes 
of  variation,  commodities  of  the  class  here  considered  are  pro- 
duced at  a  uniform  cost  and  always  sold  at  a  price  correspond- 
ing precisely  to  that  cost.  In  a  dynamic  state,  there  is  flux 
and  change,  variation  in  cost,  oscillation  of  price.  Yet  the 
dynamic  state  tends  to  subside  into  the  static.  Unless  there  be 
incessant  reappearance  of  disturbing  forces,  the  dynamic  state 
will  cease. 

The  real  problem  is  thus  not  whether  price  is  in  strict  con- 
formity to  a  cost  of  production  uniform  for  all  competitors, 
but  whether  there  is  rough  approximation  to  this  situation  and 


176  VALUE  AND  EXCHANGE 

a  tendency  toward  its  full  attainment  in  a  static  state.  And 
such  a  tendency,  to  repeat,  exists  over  a  very  large  part,  prob- 
ably the  larger  part  of  the  field  of  industry.  A  comparison  has 
often  been  made  to  the  tendency  of  the  ocean  to  keep  its  level. 
Tides,  currents,  storms,  cause  disturbances,  and  it  is  never 
true  in  a  literal  sense  that  the  level  is  maintained;  none  the 
less,  there  is  a  normal  level,  and  the  actual  height  of  the  water 
tends  to  conform  to  it.  Or  a  comparison  might  be  made  to 
the  tendency  of  the  air  to  maintain  a  certain  pressure.  This 
pressure  (measured  by  the  barometer)  is  said  to  be  29.9 
inches  at  sea  level.  In  fact,  it  may  be  more  or  less,  and 
rarely  does  the  barometer  stand  precisely  at  the  normal  figure. 
None  the  less,  it  oscillates  about  that  figure,  and  tends  to  return 
to  it.  At  any  height  above  sea  level,  there  will  again  be  oscil- 
lations, with  a  different  range,  and  with  a  tendency  to  return 
to  the  new  normal  figure. 

§  4.  By  way  of  illustration  and  explanation,  some  of  the 
disturbing  causes  may  be  briefly  considered. 

Most  universal,  perhaps,  is  lack  of  flexibility  in  supply. 
There  never  is  complete  ease  of  variation,  such  as  to  bring  about 
the  steady  accommodation  of  supply  to  the  precise  quantity 
which  will  sell  at  the  cost  price.  Even  under  the  simplest  con- 
ditions of  handicraft  production,  there  is  no  such  flexibility. 
As  plant  and  machinery  become  more  important,  every  con- 
siderable change  in  output  involves  time  and  expense.  Though 
there  is  some  flexibility  in  the  output  from  an  existing  plant, 
it  does  not  go  far.  Any  considerable  increase  in  supply  involves 
the  making  of  new  plant,  and  any  considerable  decrease  in- 
volves the  abandonment  of  some  of  the  old.  Changes  of  this 
sort,  involving  a  readjustment  of  the  preliminary  investment, 
not  only  take  place  slowly,  but  are  much  affected  by  vague 
general  sentiment.  Business  men,  not  much  less  than  others, 
go  with  the  crowd.  When  the  belief  gets  abroad  that  such 
and  such  an  industry  is  "a  good  thing,"  they  flock  into  it  with 
no  very  careful  calculation.  On  the  other  hand,  when  affairs 
go  ill,  it  is  with  reluctance  that  existing  plants  shut  down. 


VALUE  UNDER  CONSTANT  COST  177 

When  the  signs  of  increasing  demand  show  themselves,  new 
plants  are  at  first  constructed  slowly  and  hesitatingly;  then, 
at  the  later  stages  of  a  sustained  increase,  with  uncalculating 
excess.  Hence  the  oscillations  of  modern  industry,  often 
affecting  many  trades  at  once,  and  bringing  in  their  train  in- 
dustrial crises. 

The  prices  of  things  subject  to  rapid  changes  in  demand  are 
especially  fluctuating,  even  though  they  be  produced  under  con- 
ditions approximating  those  of  constant  cost.  Almost  all 
textile  goods  that  are  used  for  outer  garments  are  affected  by 
the  caprices  of  fashion.  For  textiles  worn  by  women,  the 
changes  in  the  demand  are  extraordinary.  The  stuff  which  is 
for  the  moment  in  fashion  cannot  be  turned  out  as  fast  as  the 
women  want  it;  while  that  which  was  in  fashion  but  a  year 
ago  can  hardly  be  sold  at  any  price.  Amid  such  sharp  changes 
in  demand,  supply  cannot  be  easily  accommodated,  and  the 
conformity  of  price  to  cost  works  itself  out  only  as  a  rough  sort 
of  average. 

The  conformity  of  price  to  cost  depends,  of  course,  on  the 
free  competition  of  producers.  So  far  as  there  is  combination 
or  monopoly,  it  does  not  work  itself  out.  One  of  the  most 
uncertain  problems  of  modern  industry  is  the  extent  of  monopo- 
listic combination,  —  combinations  so  effective  that  there  is  no 
longer  even  an  approximate  determination  of  price  by  cost. 
Large  scale  production  tends  to  limit  the  number  of  individual 
competitors,  and  facilitates  monopoly  conditions.  But  the 
change  in  this  direction,  striking  as  it  has  been  in  the  last  half 
century,  has  not  gone  so  far  as  to  displace  competition  over 
more  than  a  limited  range  of  industries.1  Over  the  greater  part 
of  the  economic  field  competition  is  still  in  force,  though  often 
irregularly  and  spasmodically,  and  the  tendency  is  still  for  the 
prices  of  things  to  conform  to  their  cost. 

An  important  obstacle  to  the  play  of  competition  sometimes 
arises  from  custom  and  good  will,  —  from  brands,  labels, 
trade-marks.  Where  producers  and  consumers  are  separated 

1  Compare  Book  I,  Chapter  4 ;  and  Book  VII,  Chapter  63. 


178  VALUE  AND  EXCHANGE 

by  a  long  chain  of  intermediaries,  the  consumers  often  look  to 
some  external  and  familiar  mark  in  deciding  which  among 
competing  products  they  will  select.  Hence  the  immense  part 
played  by  advertising.  It  is  a  familiar  saying  in  business 
circles  that  it  pays  to  advertise  a  good  article.  Certainly  it 
pays,  and  sometimes  pays  enormously,  to  create  and  maintain 
good  will.  He  who  has  induced  many  people  to  get  into  the 
way  of  buying  a  particular  brand,  may  sell  at  a  price  higher 
than  that  of  his  competitors,  or  sell  in  greater  volume  and  with 
more  steadiness.  No  doubt  this  sort  of  advantage  does  not 
come  by  accident.  It  is  slowly  created  by  shrewdness,  patience, 
persistence.  The  profitableness  of  a  trade-mark  is  due  at  the 
outset  to. the  business  ability  of  some  individual,  and  connects 
itself  with  questions,  to  be  considered  later,  concerning  the 
variations  of  gains  among  individual  business  men.  In  fact, 
the  whole  problem  of  competition  and  cost  is  a  fundamental 
one ;  it  ramifies  into  all  parts  of  economics ;  and  all  its  aspects 
can  be  taken  up  only  step  by  step  as  we  proceed. 

Where  production  is  on  a  large  scale,  a  very  slight  difference 
in  price,  or  change  in  price,  may  make  a  great  difference  in 
profit.  In  railway  operations,  an  extra  twentieth  of  a  cent  in 
the  charge  per  ton  per  mile  may  mean  millions  of  dollars  in 
revenue.  In  sugar  refining,  an  extra  tenth  of  a  cent  per  pound 
on  refined  sugar  means  the  difference  between  moderate  gains 
and  great  gains.  What  is  thus  true  of  a  difference  in  price, 
is,  of  course,  true  of  a  difference  in  expenses:  he  who  saves  a 
tenth  or  twentieth  of  a  cent  per  unit  of  output  is  on  the  way 
to  fortune.  Many  of  the  great  combinations  which  are  sup- 
posed to  make  vast  monopoly  profits,  and  which  in  fact  make 
unusual  profits,  do  so  by  a  very  small  margin.  Price  exceeds 
cost  by  only  a  fraction,  but  profits  exceed  the  normal  amount 
by  a  large  total. 

Those  staple  articles  which  are  used  regularly  from  year  to 
year  in  much  the  same  quantities  are  sold  at  comparatively 
even  prices,  which  are  surprisingly  close  to  constant  (i.e.  uni- 
form) costs.  So  it  is  with  flour,  with  the  ordinary  kinds  of 


VALUE  UNDER  CONSTANT  COST  179 

cotton  cloths  and  of  boots  and  shoes.  Here  are  businesses  of 
cents  :  a  fraction  more  or  less  means  the  difference  between 
profit  and  loss.  An  able  business  manager,  quick  to  introduce 
all  improvements,  will  be  turning  out  his  goods  at  a  cost 
lower  by  only  a  trifle  than  that  of  his  competitors ;  or,  having 
succeeded  in  making  a  reputation  for  a  particular  sort  of  shoe 
or  a  particular  brand  of  cloth,  he  may  get  a  price  a  trifle  higher 
than  others  get.  By  either  slight  differential  advantage  he 
will  make  large  profits.  Other  things  are  commonly  sold  with 
a  wider  "margin  of  profit"  —  i.e.  a  wider  difference  between 
expense  per  unit  and  selling  price  —  because  there  is  more  risk, 
more  irregularity,  more  balancing  of  possible  losses  against  the 
expected  rates  of  gain. 

All  these  things  need  to  be  taken  into  account  when  it  is 
said  that  price  is  governed  by  cost  of  production,  — a  proposition 
which,  to  repeat,  holds  good  only  as  a  statement  of  a  tendency, 
of  an  approximation  to  what  would  happen  in  a  "static"  state. 


CHAPTER  13 
VALUE  AND  VARYING  COSTS.     DIMINISHING  RETURNS 

§  1.  Let  us  suppose  now  that  the  several  producers  who 
compete  with  each  other  in  putting  a  given  article  on  the 
market  have  not  the  same  facilities ;  that  for  some  of  them  the 
expenses  of  production  are  greater  than  for  others.  We  need 

Y 


not  concern  ourselves  for  the  present  with  the  question  why 
there  are  such  differences.  Let  us  assume  them  to  exist,  and 
consider  what  consequences  follow. 

The  situation  is  illustrated  by  the  diagram.  The  conditions 
of  demand  are  again  indicated  by  the  descending  line  DD'. 
The  conditions  of  supply  are  indicated  by  the  rising  line  SS', 

180 


VALUE  AND  VARYING  COST  181 

The  varying  distance  from  the  horizontal  axis  OX  to  the  line 
SS'  measures  the  varying  cost  of  different  installments  of  the 
supply.  Some  producers  —  those  most  favorably  equipped  — 
can  put  the  commodity  on  the  market  at  the  comparatively 
low  cost  OS.  Perhaps  a  certain  moderate  quantity  can  be  so 
produced  at  constant  cost.  If  the  conditions  of  demand  were 
such  that  only  this  moderate  quantity  were  wanted  at  the 
constant  cost  price,  —  if  the  demand  curve  were  to  intersect 
the  supply  curve  somewhere  near  S,  —  the  normal  price  would 
be  OS.  So  far  the  case  would  be  identical  with  that  studied 
in  the  preceding  chapter.  But  now  the  conditions  of  demand, 
as  indicated  by  the  line  DD',  are  such  that  a  much  greater 
quantity  is  wanted  at  the  price  OS  than  can  be  furnished  at 
that  price.  The  supply  put  on  the  market  increases,  but  as  it 
increases,  additional  installments  can  no  longer  be  produced  at 
the  cost  OS.  With  the  quantity  OA,  for  example,  the  cost  of 
the  last  installment  reaches  A  A'.  As  more  is  produced,  cost 
still  increases,  indicated  by  the  continuing  ascent  of  the  supply 
curve  from  A'  to  P'.  At  P'  finally  the  demand  curve  is  met. 
At  the  price  BP'  (=OP)  the  quantity  OB  can  be  disposed  of. 
Equilibrium  is  established ;  the  quantity  demanded  equals  the 
quantity  supplied ;  and  price  settles  at  the  amount  BP'. 

The  whole  supply  will  be  sold  at  the  price  OP  ( =  BP') ;  and 
the  selling  value  of  the  whole,  i.e.  the  quantity  multiplied  by  the 
price,  will  be  indicated  by  the  rectangle  OPP'B.  It  is  true 
that  the  more  fortunate  producers  could  sell  the  commodity 
to  advantage  at  a  less  price.  At  the  price  OS  or  A  A'  they 
would  still  find  it  worth  while  to  bring  it  to  market.  But  the 
total  quantity  which  will  meet  the  demand  at  an  equilibrium 
price  cannot  be  supplied  unless  producers  less  fortunate  con- 
tribute their  quota.  These  will  not  do  so  unless  they  get  their 
higher  cost  price  BP'.  At  that  price  the  whole  supply  will 
be  disposed  of.  The  more  favorably  situated  producers  will 
get  the  price  necessary  to  induce  their  rivals,  who  have  poorer 
facilities,  to  contribute  to  the  supply. 

We  may  speak  of  the  producers  at  B,  whose  cost  of  produc- 


182  VALUE  AND  EXCHANGE 

tion  is  BP',  as  the  marginal  producers.  Their  cost  price  is 
also  the  measure  of  the  marginal  utility  of  the  commodity. 
Marginal  cost  and  marginal  utility  thus  coincide;  and  when 
they  coincide,  there  is  equilibrium.  If  the  quantity  supplied 
should  increase  beyond  B,  in  the  direction  of  F,  marginal 
utility  would  be  less,  and  marginal  cost  would  be  greater. 
Supply  could  not  long  be  maintained  beyond  the  point  B,  for 
producers  would  then  be  receiving  less  than  cost.  So  long  as 
the  conditions  of  demand  and  supply  remained  as  indicated  by 
the  lines  DD'  or  SS',  price  would  settle  at  the  amount  BP'. 

The  relation  of  demand  and  supply  to  value  is  somewhat 
different  here  from  what  it  was  in  the  cases  discussed  in  the 
preceding  chapters.  Where  the  supply  of  a  commodity  is 
fixed  (the  case  which  underlies  the  reasoning  of  Chapter  10), 
the  value  of  a  commodity  is  settled  by  the  conditions  of  demand ; 
that  is,  by  the  marginal  utility  of  that  supply.  Where,  on  the 
other  hand,  the  cost  of  a  freely  produced  commodity  is  fixed 
(the  case  discussed  in  Chapter  12),  the  value  of  the  commodity 
is  settled  by  the  conditions  of  supply;  that  is,  by  cost. 
Demand  in  this  case  determines,  in  the  long  run,^only  the 
quantity  which  shall  be  put  on  the  market.  But  in  the  case 
now  under  consideration,  the  conditions  of  demand  and  of 
supply  both  have  a  permanent  influence  in  settling  price.  As 
the  quantity  shifts,  not  only  does  marginal  utility  vary,  but 
marginal  cost.  A  lessening  of  demand  would  not  only  lessen 
the  quantity  put  on  the  market,  but  would  also  lessen  mar- 
ginal cost.  Conversely,  an  increase  of  demand  would  not  only 
cause  more  to  be  put  on  the  market,  but  would  also  raise  normal 
price,  since  the  additional  quantity  would  be  produced  at 
greater  cost.  Hence  demand  and  supply  —  marginal  utility 
and  cost  —  mutually  determine  normal  price. 

The  economist  who  has  best  set  forth  the  general  theory  of 
value,  Professor  Marshall,  has  ingeniously  compared  the 
influence  of  demand  and  supply  to  the  working  of  a  pair  of 
scissors.  If  one  blade  of  a  pair  of  scissors  is  held  still,  and  the 
other  moves,  we  may  say  that  the  second  does  the  cutting. 


VALUE  AND  VARYING  COST  183 

Yet  it  could  not  cut  unless  the  other  blade  were  there.  So 
when  supply  is  fixed,  we  may  say  that  demand  settles  value; 
yet  it  does  so  only  because  supply  is  there  and  does  not  move. 
When  cost  is  constant,  we  may  say  that  cost  settles  value. 
Yet  it  does  so  only  because  there  is  a  demand  for  the  com- 
modity, and  because  supply  readily  adjusts  itself  to  the  amount 
which  will  be  demanded  at  the  cost  price.  If  cost  is  variable 
in  the  manner  discussed  in  the  present  chapter,  both  supply 
and  demand  —  both  cost  and  utility  —  exercise  a  mutual 
influence  on  normal  price.  Both  blades  of  the  scissors  are  in 
motion.  All  the  various  manifestations  of  value  (under  the 
conditions  of  an  advanced  division  of  labor  and  of  exchange 
flowing  from  that  division)  can  be  analyzed  as  interactions  of 
supply  and  demand.  Neither  can  be  said  to  settle  value  in- 
dependently of  the  other. 

§  2.  The  differences  in  advantage  between  producers  may 
be  due  to  permanent  or  to  temporary  causes.  According  as  they 
are  temporary  or  permanent,  they  are  of  very  different  signifi- 
cance for  the  theory  of  value  and  for  the  welfare  of  society. 

Differences  of  a  temporary  sort  are  the  most  common. 
They  are  so  common  that  they  may  be  said  in  one  sense  to  be 
universal.  As  indicated  in  the  last  chapter,  it  probably  never 
happens  in  communities  familiar  to  us,  that  all  those  engaged 
in  a  given  industry  are  carrying  on  their  operations  in  the 
same  way.  Some  have  better  plant,  better  organization, 
better  location,  than  others ;  can  bring  their  products  to  market 
at  less  expense ;  and,  selling  at  the  same  price,  can  reap  larger 
gains. 

But  these  differences,  if  their  causes  are  not  permanent, 
tend  constantly  to  disappear.  If  one  man  has  better  plant  or 
machinery  than  another,  and  if  there  be  no  permanent  reason 
why  the  second  should  not  also  set  up  the  better  outfit,  he  is 
likely  sooner  or  later  to  do  so.  If  he  does  not  do  so,  he  is  likely 
to  be  driven  out  of  the  market.  Others  will  adopt  the  more 
effective  method  of  production,  will  increase  the  quantity 
they  put  on  the  market,  and  will  be  able  to  undersell  him 


184  VALUE  AND  EXCHANGE 

without  foregoing  a  profit.  Where  the  methods  of  cheapened 
production  are  open  to  all,  they  are  sure  sooner  or  later  to  be 
adopted  by  all. 

We  say,  sooner  or  later ;  for  the  process  takes  time,  especially 
when  changes  in  the  arts  are  rapid.  The  civilized  world  has 
been  for  generations  in  a  dynamic  state.  More  or  less  tem- 
porary causes  of  differences  are  constantly  appearing,  dis- 
appearing, and  reappearing.  At  any  given  time,  the  usual 
conditions  are  not  those  of  uniform  cost,  but  of  varying  cost. 

But  under  these  conditions  value  cannot  be  said  to  be  deter- 
mined by  marginal  cost  of  production.  Value  is  always  deter- 
mined proximately  by  the  marginal  utility  of  the  supply.  Given 
the  total  supply  that  comes  on  the  market,  —  whether  put  on  in 
large  sudden  doses,  or  by  gradual  increments,  —  and  the  price 
will  be  such  that  the  whole  is  sold.  For  the  marginal  pro- 
ducer this  price  may  or  may  not  be  equal  at  any  given  time 
to  cost.  With  the  oscillations  of  demand,  and  the  various 
causes  of  nonadjustment  to  normal  conditions  which  were 
considered  in  the  preceding  chapter,  the  season's  price  may  be 
such  as  to  make  the  marginal  producer  prosperous,  or  such  as 
to  make  him  a  bankrupt.  If  he  becomes  prosperous,  his  more 
enterprising  and  successful  rivals,  the  infra-marginal  producers, 
become  even  more  so,  and  are  tempted  to  extend  their  opera- 
tions. If  he  is  on  the  way  to  bankruptcy,  they  may  yet  be  able 
to  hold  their  own.  In  time,  he  disappears,  and  his  better- 
equipped  or  better-situated  rivals  supplant  him.  In  time,  too, 
it  is  cost  of  production  at  their  hands  which  acts  on  supply,  and 
thus  acts  on  price.  In  other  words,  disregarding  temporary  and 
seasonal  fluctuations,  the  principle  of  constant  cost  regulates 
long-run  value  where  there  are  non-permanent  differences  be- 
tween rival  producers.  In  such  a  case,  it  is  cost  of  production  at 
the  hands  of  the  more  capable  and  better-equipped  producers, 
not  cost  of  production  at  the  hands  of  the  marginal  producer, 
that  settles  the  long-run  price  as  distinguished  from  the  market 
price.1 

1  Compare  what  is  said  in  Book  V,  Chapter  50,  §§  1,  2. 


VALUE  AND  VARYING  COST  185 

The  situation  is  otherwise  where  there  are  permanent  causes 
of  difference  between  producers.  Then  cost  at  the  hands  of  the 
marginal  producer  does  settle  the  long-run  price.  The  point 
about  which  oscillations  range,  and  to  which  price  tends  to  con- 
form, is  cost  for  the  least  advantageous  producer.  Without 
him,  the  total  supply  cannot  be  enlarged  to  the  point  at  which 
there  is  an  equilibrium  of  normal  supply  and  demand.  If  there 
were  no  limit  to  the  amount  which  the  more  advantageous  pro- 
ducers could  bring  to  market,  —  if  this  fortunate  set  of  producers 
could  increase  the  output  indefinitely  at  constant  cost,  —  the 
marginal  producer  would  be  driven  out,  and  the  conditions 
would  be  those  of  constant  cost.  There  being  such  a  limit,  he 
must  be  called  on  for  the  maintenance  of  supply,  and  there 
must  be  in  the  long  run  a  price  which  will  make  it  worth  his 
while  to  contribute.  Value  is  then  determined  in  the  long  run  by 
cost  to  the  marginal  producer ;  but  at  what  point  in  the  varying 
scale  of  costs  that  producer  will  be,  depends  on  the  conditions  of 
demand. 

§  3.  Instead  of  speaking  of  varying  cost,  or  increasing  cost, 
we  may  speak  of  diminishing  returns. 

Increasing  cost  and  diminishing  returns  are  opposite  aspects  of 
the  same  tendency.  Looking  again  at  the  diagram,  we  may  see 
that  the  marginal  producer  at  B  has,  for  the  same  addition  to  the 
supply,  greater  expenses  than  the  better-situated  producers  at 
A  and  0.  As  the  quantity  put  on  the  market  increases  along  the 
axis  OX,  cost  for  every  fresh  installment  becomes  greater.  With 
every  proportional  increase  in  outlay,  there  is  a  less  addition  to 
the  supply,  —  a  tendency  to  diminishing  return. 

It  matters  not  whether  we  say  that  the  tendency  to  diminish- 
ing return  is  felt  by  the  infra-marginal  producers  themselves, 
or  by  those  whom  we  have  regarded  as  the  marginal  producers. 
It  is  felt  by  both.  There  is  an  increase  of  cost  as  supply  in- 
creases, and  the  price  must  be  such  as  to  make  the  increased  cost 
worth  while.  Those  who  are  better  situated  may  find,  as  they 
try  to  enlarge  their  contribution  to  the  supply,  that  they 
cannot  do  so  on  the  same  relatively  easy  terms  as  for  the 


186  VALUE  AND  EXCHANGE 

earlier  installments :  they  encounter  diminishing  returns.  Oi 
this  same  difficulty  may  be  met  by  others  who  add  to  the 
supply.  Given  the  tendency,  the  result  remains  that  normal 
price  settles  at  the  point  of  cost  of  production  for  the  last 
increment.  It  would  be  more  accurate,  therefore,  to  speak  of 
the  marginal  product  or  marginal  increment,  than  of  the  mar- 
ginal producer,  as  fixing  the  long-run  price. 

Though  we  use  the  term  "  cost "  in  this  series  of  chapters  in  the 
sense  of  outlays  by  a  capitalist,  and  measure  increasing  cost  by 
the  increase  in  outlays  as  additional  supplies  are  brought  to 
market,  the  cause  of  this  rising  cost  is  commonly  an  increase  of 
cost  in  the  other  sense,  —  cost  in  terms  of  labor,  exertion,  sacri- 
fice, or  disability.1  When  additional  supplies  of  a  commodity 
bring  permanently  greater  expense  to  the  producing  capitalist, 
this  result  is  usually  due  to  the  fact  that  more  labor  is  required  or 
a  greater  volume  of  capital  is  called  for,  i.e.  more  saving  by  those 
who  furnish  the  capital.  The  distinction  between  expenses  of  pro- 
duction and  cost  in  the  sense  of  labor  and  sacrifice,  though  it  will 
be  found  of  great  significance  for  some  problems,  is  not  impor- 
tant here.  Where  expense  increases  permanently  for  successive 
additions  to  supply,  —  where  returns  diminish  in  proportion  to 
outlay,  —  we  have  also  diminishing  returns  in  the  sense  that 
the  same  labor  yields  a  lessening  output.  That  part  of  the 
theory  of  value  which  we  are  considering  in  this  chapter  has  its 
foundation  mainly  in  some  unalterable  conditions  in  the  world 
about  us :  in  the  fact  that  nature  enables  labor  to  be  applied 
less  advantageously  under  some  conditions  than  under  others, 
and  that  the  continued  application  of  labor  on  even  the  most 
advantageous  sites  meets  sooner  or  later  a  tendency  to  diminish- 
ing return. 

§  4.  In  what  circumstances,  and  over  how  great  a  range  of 
industries,  do  we  find  varying  cost,  or  diminishing  returns  ?  In 
general,  differences  in  cost  are  permanent  in  the  extractive 
industries,  —  in  agriculture,  forestry,  mining. 

In  agriculture,  good  land  yields  more  to  labor  than  land  less 

i  See  Chapter  12,  §  1. 


VALUE  AND  VARYING  COST  187 

good.  The  prairies  of  Illinois  are  more  fertile  than  the  stony 
fields  of  New  England,  and  the  black  earth  of  Russia  than  the 
sandy  soil  of  Brandenburg.  All]  the  climatic  factors  —  such  as 
sunshine,  precipitation,  the  length  of  the  seasons  —  have  their 
influence,  as  well  as  the  physical  and  chemical  constitution  of 
the  soil.  Of  these  and  their  effects  we  shall  have  occasion  to  say 
more  at  a  later  stage ;  it  suffices  here  to  emphasize  the  obvious 
fact  that  there  are  differences.1 

Not  only  are  there  such  differences,  but  there  is  further 
an  unmistakable  tendency  to  diminishing  returns  on  any 
plot  of  land.  The  amount  of  produce  which  can  be  obtained 
from  the  best  land  is  limited ;  and  the  amount  which  can  be  ob- 
tained from  that  land  under  the  best  conditions  is  limited.  By 
applying  more  labor  and  capital,  it  is  usually  possible  to  add  to 
the  produce  from  a  given  piece  of  land ;  but  it  is  not  possible  to 
get  more  produce  in  proportion  to  the  addition  of  labor  and  capi- 
tal. Hence  there  are  permanent  differences,  not  only  between 
different  soils,  but  between  the  successive  applications  of  labor 
and  capital  on  the  same  soil.  So  agricultural  production  pre- 
sents typically  the  application  of  the  principle  of  value  which 
we  are  now  considering. 

In  forests,  likewise,  there  are  obvious  differences  of  the  same 
sort.  Some  are  better  than  others.  Advantage  in  location 
and  accessibility  plays  no  less  a  part  than  advantage  in  the  size 
and  character  of  the  timber;  yet  either  kind  of  advantage 
counts.  Mines  present  differences  of  an  analogous  kind ;  they 
are  affected  both  by  accessibility  to  the  market  and  intrinsic 
productiveness.  Both  forests  and  mines  have  industrial  pecul- 
iarities, especially  in  their  development  during  very  modern 
times ;  but  of  both,  the  general  conditions  of  varying  cost  and 
diminishing  returns  hold  good. 

In  manufacturing  industries,  which  shape  and  transform  the 
materials  brought  out  by  the  extractive  industries,  the  principle 
of  diminishing  returns  is  applicable  in  less  degree.  But,  though  the 
differences  in  cost  between  competing  producers  are  commonly 

1  See  Book  V,  Chapter  42. 


188  VALUE  AND  EXCHANGE 

of  the  transitional  or  "dynamic"  sort,  they  sometimes  have 
permanent  causes.  One  manufacturer  may  have  more  water 
power  than  others,  or  an  unequaled  site  on  a  harbor  front.  In 
the  earlier  days  of  the  development  of  power  and  machinery,  a 
first-rate  water  power  was  of  great  advantage.  Later,  steam 
largely  superseded  water  power;  partly  because  of  the  great 
advances  in  the  efficiency  and  economy  of  steam  engines,  partly 
because  they  could  be  set  up  at  any  desired  place,  and  so  per- 
mitted better  access  to  markets  or  to  materials.  In  recent 
years  the  generation  and  transmission  of  electric  power  has  again 
made  falling  water  more  important,  and  may  prove  the  cause 
of  enduring  differences  in  the  effectiveness  of  manufacturing  es- 
tablishments. In  the  main,  however,  the  poorer  establishments 
do  not  maintain  themselves  indefinitely  side  by  side  with  the 
better.  They  are  steadily  displaced  by  the  better,  and  these  by 
the  still  better.  The  causes  of  difference  are  not  as  permanent, 
nor  do  they  affect  so  many  branches  of  production,  as  in  the 
extractive  industries. 


CHAPTER  14 
VALUE  AND  INCREASING  RETURNS 

§  1.  In  the  preceding  chapter  the  theory  of  value  was  applied 
to  the  conditions  of  increasing  cost  or  diminishing  returns.  We 
turn  now  to  the  reverse  conditions,  those  of  diminishing  cost  or 
increasing  returns. 

Suppose  that,  as  additional  supplies  of  a  commodity  are  pro- 
duced, the  cost  of  each  unit  becomes  not  greater,  but  less. 
Such  a  tendency  is  represented  in  the  Figure  7  where  line  SS', 
indicating  the  conditions  of  supply,  has  a  downward  slope.  The 
line  DD',  representing  the  conditions  of  demand,  necessarily 
has  a  downward  slope,  indicating  the  diminishing  utility  of  suc- 
cessive increments.  Equilibrium  will  be  reached  at  the  point 


190  VALUE  AND  EXCHANGE 

where  the  two  curves  meet,  at  Pr.  At  that  point  the  quantity 
brought  to  market  sells  at  the  price  BP',  which  equals  its  cost  of 
production.  The  total  quantity  put  on  the  market  will  nor- 
mally be  OB,  and  its  total  selling  price  will  be  OPP'B. 

It  is  to  be  observed  that  this  figure  represents  a  situation  differ- 
ent in  essential  respects  from  that  represented  in  Figure  6  in  the 
preceding  chapter.  In  that  case  some  among  the  competing 
producers  were  supposed  to  contribute  to  the  supply  at  less  cost 
than  others.  They  reaped  a  producer's  surplus.  In  the  present 
case,  however,  all  producers  are  on  the  same  plane ;  all  have  the 
advantage  of  lessening  cost  and  increasing  returns.  No  por- 
tion of  the  supply  continues  to  be  produced  at  a  cost  different 
from  the  marginal  cost.  With  the  supply  OB,  for  example,  the 
cost  per  unit  of  the  commodity  is  BP'  for  each  and  every  pro- 
ducer. If  for  any  reason  the  supply  should  be  reduced,  cost  for 
each  unit  would  be  greater.  Suppose,  for  example,  that  demand 
should  decline,  the  demand  curve  shifting  to  the  left,  to  dd',  so  as 
to  intersect  the  supply  curve  at  A'.  The  quantity  normally 
supplied  would  then  be  OA,  selling  at  the  price  A  A'.  All  pro- 
ducers would  find  their  cost  per  unit  higher  than  when  the  quan- 
tity supplied  was  OB ;  for  A  A'  is  greater  than  BP'.  But  at 
neither  price  would  there  be  differences  between  producers. 
Total  cost  and  total  selling  value  in  either  case  would  be  repre- 
sented by  parallelograms;  at  the  price  A  A '  by  the  area 
OAA'C,  and  at  the  price  BP'  by  the  area  OPP'B.  There  is  no 
such  phenomenon  as  surplus  gain  to  any  producer. 

This  case  differs,  again,  from  that  considered  in  the  latter 
part  of  Chapter  12.  There  the  effect  of  a  general  lowering  of 
the  supply  schedule  was  considered,  on  the  supposition  that 
the  reduction  was  due  to  some  extraneous  cause  not  directly 
connected  with  increase  in  supply.  Here  the  reduction  is  sup- 
posed to  be  directly  due  to  such  an  increase  :  the  mere  fact  of 
greater  supply  brings  a  decline  in  cost  per  unit  of  supply.  Cost, 
uniform  for  all  producers,  becomes  less  for  each  as  more  is  pro- 
duced. 

All  these  three  cases,  on  the  other  hand,  are  alike,  in  that  long- 


VALUE  AND  INCREASING  RETURNS  191 

run  results  are  considered.  Uniformity  of  costs,  and  the  auto- 
matic decline  in  cost  for  all  producers  with  increasing  supply, 
never  are  found  in  industry.  Where  the  conditions  are  favorable 
for  a  general  decline  in  cost,  some  producers,  as  we  have  seen, 
take  advantage  of  them  more  promptly  than  others;  and  so 
long  as  this  "dynamic"  situation  continues,  we  have  a  lowering 
of  cost  for  some  producers,  but  not  for  all.  This  situation,  how- 
ever, will  not  endure  :  those  who  do  not  avail  themselves  of  the 
improvements  are  underbid  and  driven  from  the  market,  and 
the  "static"  state  of  uniform  cost  is  approached.  The  case 
would  be  different  if  those  who  had  the  better  facilities  were 
not  subject  to  competition  from  others  on  even  terms,  and  could 
not  themselves  increase  their  output  indefinitely  at  lower  cost. 
With  such  a  limitation  to  their  advantages,  we  should  have 
precisely  the  case  of  varying  costs,  as  discussed  in  the 
preceding  chapter.  Here  cost  is  supposed  to  be  uniform,  but 
not  constant,  —  it  becomes  less  per  unit  as  the  number  of 
units  increases.  The  long-run  result  is  an  interaction  of 
demand  and  supply ;  both  blades  of  the  scissors  are  cutting. 

§  2.  What  now  are  the  industries  in  which  there  is  a  tendency 
to  increasing  return,  and  what  are  the  causes  of  this  tendency  ? 

The  first  question  is  comparatively  easy  to  answer.  The 
tendency  appears  in  manufacturing,  in  transportation,  in  mining, 
—in  all  the  industries  in  which  we  have  seen  the  tendency  to  large- 
scale  production.  In  agriculture,  though  it  sometimes  appears 
as  a  passing  phase,  it  is  not  ordinarily  found  at  all ;  and  the  same 
is  true  of  systematic  forestry.  The  greater  the  extent  to  which 
plant  and  machinery  can  be  used,  the  more  concentrated  the 
industry  and  the  smaller  the  area  on  which  a  given  volume  of 
production  can  be  turned  out,  the  more  probable  is  the  tendency 
to  lessening  cost  and  increasing  return. 

The  second  question  calls  for  some  discrimination.  Increas- 
ing returns  may  be  due  to  external  economies  or  to  internal 
economies, — again  phrases  suggested  by  Professor  Marshall, 
and  pointing  to  forces  different  in  character  and  effect.  Further, 
increasing  returns  may  be  due  to  changes  in  the  arts,  or  may 


192  VALUE  AND  EXCHANGE 

take  place  even  without  them.  It  is  not  always  easy  to  separate 
those  causes  of  increasing  return  which  act  under  static  con- 
ditions from  those  which  act  under  conditions  of  progress  in  the 
arts.  Yet  it  will  make  the  subject  clearer  if  at  the  outset  we 
take  up  the  two  cases  independently. 

First,  consider  external  economies.  These  are  such  as  arise 
outside  of  the  establishment  which  gains  thereby  in  efficiency 
and  in  diminution  of  cost.  An  example  at  once  simple  and 
typical  is  the  diminution  in  cost  of  machinery  and  adjuncts, 
as  these  are  made  in  larger  quantities.  The  more  cotton 
mills  there  are,  and  the  more  machinery  they  use,  the 
larger  the  scale  on  which  the  machinery  itself  can  be  made. 
As  the  machinery  becomes  cheaper  the  expenses  of  the  cotton 
manufacturer  become  less.  Again,  the  construction  of  large 
steel  ships  in  the  United  States  is  now  carried  on  for  a  much 
smaller  tonnage  than  in  Great  Britain.  Consequently  various 
adjuncts  needed  for  ships, —  compasses,  capstans,  winches, 
donkey-engines,  sundry  vessel  fittings  —  are  called  for  in  much 
larger  quantity  in  Great  Britain,  are  systematically  and  uni- 
formly made  on  a  larger  scale,  and  are  cheaper  for  the  ship- 
builder. These  external  economies  would  indeed  be  at  the 
disposal  of  the  American  shipbuilder  if  he  could  buy  such 
things  in  Great  Britain  without  restriction.  But  the  United 
States  imposes  on  them  a  heavy  customs  duty.  Within  the 
country,  they  are  made  in  less  quantity  than  in  Great  Britain ; 
indeed,  often  they  have  to  be  made  separately  for  each  ship. 
Whether  procured  from  abroad  or  at  home,  they  are  therefore 
dearer.  In  consequence,  the  shipbuilder  finds  this  item  of 
expense  greater  than  it  would  be  if  ships  were  built  in  large 
numbers  in  the  United  States.  Still  another  example  is  in  the 
boot  and  shoe  manufacture.  When  this  is  carried  on  exten- 
sively, and  especially  when  a  number  of  establishments  are  in 
the  same  locality,  subsidiary  industries  arise  which  supply 
cheaply  the  special  tools,  materials,  and  fittings,  —  the  shoe- 
strings, eyes,  metal  fittings,  the  paper  boxes  for  packing,  not 
to  mention  the  machinery.  The  gain  in  external  economies  of 


VALUE  AND  INCREASING  RETURNS  193 

this  sort  is  one  of  the  reasons  for  the  concentration  of  an  in- 
dustry in  a  given  place;  of  shoe  manufacturing  in  Brockton 
and  Lynn,  of  silk  manufacturing  in  Paterson,  of  cotton  manu- 
facturing in  Lowell  and  Fall  River,  of  metal  wares  in  Bridgeport. 
In  every  such  place  the  factories,  merely  because  of  their  num- 
ber, command  resources  and  economies  which  an  isolated 
establishment  finds  hard  to  secure. 

An  important  gain  of  this  sort  comes  from  the  presence  of  a 
large  experienced  labor  force.  In  almost  every  establishment 
the  workmen  are  more  or  less  shifting.  The  changes  are  more 
frequent  in  industries  exposed  to  seasonal  fluctuations,  as  the 
boot  and  shoe  manufacture  is,  or  to  irregularities  in  demand, 
as  in  the  case  of  establishments  making  machinery.  They  are 
less  frequent  where  steady  wants  are  supplied  by  staples,  as 
in  the  soap  manufacture,  and  where  long-established  businesses 
are  conducted  by  firms  of  settled  prestige.  In  many  ways 
they  are  unfortunate,  yet  seem  to  be  an  inevitable  outcome  not 
only  of  the  variations  in  demand  for  labor  and  its  supply, 
but  of  the  monotony  of  factory  labor.  Certain  it  is  that 
workmen  come  and  go,  and  new  men  must  be  found  to 
replace  those  who  leave.  They  are  more  likely  to  be  found  in 
manufacturing  centers,  and  in  centers  where  there  are  indus- 
tries of  the  same  sort  or  of  similar  sorts.  No  doubt  there  are 
drawbacks  for  the  employer  in  such  centers.  His  laborers  are 
more  likely  to  be  organized  in  unions,  and  to  press  for  higher 
wages ;  and  the  expense  of  urban  sites  needs  to  be  considered.1 
But  the  fact  that  manufacturing  towns  grow  shows  that  they 
offer  net  advantages.  In  an  isolated  establishment,  the  loss 
of  a  few  skilled  and  trained  workmen  may  cripple  the  whole. 
But  in  an  industry  which  has  grown  to  considerable  dimen- 
sions, and  which  is  concentrated  in  certain  towns  or  districts, 
there  is  a  general  diffusion  of  skill  in  its  various  branches. 
The  smooth  and  continuous  conduct  of  operations  is  promoted 
by  this  external  economy. 

§  3.   Internal  economies  are  those  which  arise  within  the 

1  Compare  what  is  said  in  Book  V,  Chapter  43. 


194  VALUE  AND  EXCHANGE 

establishment  itself,  and  are  independent  of  the  general  growth 
of  the  industry.  All  the  gains  from  the  extension  of  large- 
scale  production  (as  distinguished  from  increasing  volume  of 
production)  are  of  this  sort,  —  the  gains  from  larger  plant  and 
more  effective  power,  from  greater  specialization  of  machinery, 
better  handling  of  materials,  more  elaborate  division  of  labor 
among  the  workmen,  and  more  refined  adaptation  of  each 
man's  task  to  his  capacity.  One  of  the  most  interesting  ques- 
tions in  regard  to  these  advantages  and  their  limits  is  the 
extent  of  the  gain  which  comes  from  horizontal  combination, 
—  from  the  union  under  single  management  of  a  number  of 
single  establishments  each  of  which  has  developed  within  itself 
the  more  immediate  internal  economies.  It  is  not  certain  how 
far,  in  the  long  run,  horizontal  combination  leads  to  still  further 
internal  economies.  Nor  is  it  clear  how  far  vertical  combina- 
tion, or  the  integration  of  industry,  leads  to  internal  economies. 
It  seems  to  do  so  beyond  doubt  in  some  of  the  great  industries 
of  modern  times,  especially  in  the  iron  manufacture.  But  in 
other  directions  it  has  not  made  such  unmistakable  progress. 
In  most  industries,  the  enlargement  of  the  industrial  unit 
beyond  a  certain  point,  whether  in  combination  horizontally 
with  similar  units  or  vertically  with  related  units,  does  not 
seem  to  lead  with  certainty  to  internal  economies. 

If  internal  economies  were  attained  indefinitely  as  the  scale 
of  operations  increased,  the  stage  would  be  eventually  reached 
of  complete  concentration  and  complete  monopoly.  If  each 
establishment,  or  each  combination  of  establishments,  found 
as  it  grew  in  size  that  its  efficiency  and  its  economies  increased, 
the  successively  enlarging  enterprises  would  undersell  those 
rivals  who  failed  to  enlarge,  and  finally  nothing  would  be  left 
but  one  giant  in  sole  possession  of  the  field.  This  is  the  theo- 
retically complete  "trust,"  able  to  undersell  all  rivals  by  virtue 
of  its  economies  in  production.  Such  a  trust  has  a  monopoly, 
but  evidently  a  tempered  monopoly.  Prices  cannot  be  raised 
beyond  the  point  at  which  producers  who  operate  on  a  smaller 
scale  can  compete.  If  the  rate  at  which  internal  economies 


VALUE  AND  INCREASING  RETURNS 


195 


accrue  is  slow,  —  if  the  cheapening  of  production  from  each 
enlargement  of  the  scale  of  operations  is  slight,  —  this  check 
on  the  power  of  the  monopoly  is  substantial. 

§  4.  In  the  first  section  of  this  chapter,  the  supposition  was 
tacitly  made  that  there  is  only  one  point  of  equilibrium  un- 
der  conditions  of  increasing  returns,  and 
the  Figure  on  p.  190  was  constructed  on 
this  supposition.     But  a  very  little  con- 


sideration shows  that  there  may  be  two  points  of  equilibrium. 
The  demand  and  supply  curves  have  the  same  inclination,  and 
may  intersect  at  more  points  than  one.  The  above  Figure  (Fig.  8) 
illustrates  this  possibility.  SS'  intersects  DD'  at  A',  again  at 
B',  again  at  C".  (Let  the  reader  disregard  for  the  moment  the 
dotted  line  ss'.)  A'  is  a  point  of  stable  equilibrium ;  so  is  C'. 
B'  is  not  a  point  of  stable  equilibrium.  It  is  true  that  the 
demand  and  supply  curves  intersect  at  this  point.  Immediately 
beyond  B',  however,  the  demand  curve  is  above  the  supply 
curve ;  demand  price  is  higher  than  supply  price.  An  in- 
crease of  output  beyond  B  would  be  profitable  to  producers, 


196  VALUE  AND  EXCHANGE 

since  the  commodity  can  be  sold,  in  the  quantities  between  B 
and  C,  at  prices  higher  than  cost  of  production.  But  C"  is 
again  a  point  of  true  equilibrium ;  since  the  supply  price  be- 
yond C'  is  higher  than  the  demand  price,  and  an  increase  of 
supply  beyond  C  would  be  unprofitable.  Both  A'  and  C'  are 
thus,  to  repeat,  points  of  stable  equilibrium.  Price  might  set- 
tle at  either,  and  remain  at  either  It  is  indeed  conceivable 
that  a  body  of  venturesome  producers  would  extend  supply  be- 
yond A,  confident  that  cost  per  unit  would  decline  unfailingly 
with  increase  of  total  output,  and  that  eventually  (after  B  was 
passed)  demand  price  would  again  be  above  supply  price.  But 
the  outcome  of  expansion  of  this  sort  must  appear  uncertain. 
If  equilibrium  were  established  at  A',  it  would  presumably  re- 
main; yet  if  it  were  established  at  C',  it  would  also  remain. 
Theoretically  there  may  be  an  indefinite  number  of  such  points 
of  stable  equilibrium. 

But  though  there  is  this  possibility  of  several  points  of  equilib- 
rium, actual  conditions  probably  present  very  rare  instances 
of  the  sort.  A  steep  slope  like  that  of  the  line  SS'  is  less  rep- 
resentative of  what  usually  happens  than  a  gentle  slope  like 
that  of  the  dotted  line  ssf.  Such  a  dotted  line  is  likely  to 
meet  DD'  but  once  (at  C",  the  third  point  of  intersection  for 
SS').  It  is  not  widely  different  from  the  horizontal  line  which 
represents  the  conditions  of  constant  cost. 

External  economies  are  most  likely  to  affect  cost  in  the  man- 
ner last  described.  As  a  rule,  they  operate  slowly,  almost  im- 
perceptibly, bringing  a  steady  tendency  toward  lessening  of 
expenses  with  increase  of  output,  yet  a  tendency  so  gradual 
that  for  any  given  season  or  series  of  seasons  the  conditions 
may  seem  to  differ  little  from  those  of  constant  cost. 

Internal  economies,  on  the  other  hand,  sometimes  are  rapid 
in  their  introduction  and  operation.  This  happens  especially 
when  great  changes  take  place  in  the  arts,  and  when  a  new 
commodity  is  brought  into  use. 

Changes  in  the  arts  and  inventions,  though  they  do  not  neces- 
sarily affect  either  the  total  output  or  that  of  the  individual 


VALUE  AND  INCREASING  RETURNS  197 

establishment,  yet  commonly  affect  both.  The  cheapening  of 
goods  which  results  from  improvements  usually  stimulates 
demand  in  considerable  degree,  causes  the  total  output  to  be 
larger,  and  so  brings  into  operation  external  economies  as  well 
as  additional  internal  economies.  Improvements  have  com- 
monly been  in  the  direction  of  larger  plant  and  more  expensive 
machinery,  greater  division  of  labor,  production  on  a  larger 
scale.  Not  infrequently  the  arts  have  advanced  so  fast  as  to 
cause  an  abrupt  diminution  of  cost,  leave  the  equilibrium  of 
supply  and  demand  unsettled  for  years,  and  afford  at  least 
the  possibility  of  more  than  one  point  of  equilibrium.  Besse- 
mer's  invention  immensely  reduced  the  cost  of  steel  making; 
it  also  involved  expensive  plant  and  machinery;  it  gave  great 
opportunities  for  large-scale  production  and  highly  elaborated 
organization;  it  thus  led  to  very  rapidly  declining  cost.  The 
application  of  machinery  to  watch  making  has  led  to  similar 
results;  and  in  this  case  the  commodity  was  one  subject  to  a 
very  elastic  demand,  hence  with  a  possibility  of  multiple  points 
of  equilibrium. 

New  commodities,  introduced  suddenly  or  rapidly,  often 
bring  a  strong  tendency  to  decreasing  cost  with  increasing 
supply.  When  first  offered,  they  are  strange  to  the  buying 
public,  must  break  the  crust  of  habit,  must  wait  for  a  read- 
justment of  other  devices  and  wants.  Being  thus  marketable 
in  small  quantities  only,  they  are  produced  on  a  small  scale. 
As  they  become  familiar  and  in  wide  use,  the  quantity  that 
can  be  sold  greatly  increases,  production  on  a  large  scale  be- 
comes possible,  both  internal  and  external  economics  are  intro- 
duced effectively,  and  cost  of  production  declines  rapidly. 
The  demand  schedule  for  such  articles  often  shows  a  high 
degree  of  elasticity,  especially  in  the  lower  ranges,  as  the  articles 
come  into  common  use.  The  history  of  the  bicycle  illustrates 
this  development :  its  slow  introduction  in  the  early  stages, 
its  rapidly  increasing  favor  when  once  accepted  and  generally 
used,  its  rapid  decline  in  cost  and  price  when  produced  in  larger 
quantities  and  on  a  larger  scale. 


198  VALUE  AND  EXCHANGE 

Not  infrequently  it  happens,  however,  that  a  new  com- 
modity is  patented  or  in  some  other  way  falls  under  single 
control.  This  situation  brings  a  new  complication,  arising 
from  monopoly :  the  subject  of  the  next  chapter. 


CHAPTER  15 

MONOPOLY  VALUE 

§  1.  A  monopolized  commodity  will  be  sold,  by  a  person 
doing  business  for  gain,  on  such  terms  as  will  yield  the 
largest  net  revenue.  We  may  assume,  at  the  outset  at  least,  that 
persons  possessed  of  a  monopoly  act  with  shrewdness,  and  ad- 
just their  supply  with  intelligence  and  success  so  as  to  secure 
this  maximum  gain. 

We  say,  adjust  the  supply;  for  this  is  the  mode  in  which 
the  monopolist  can  affect  price  and  profit.  The  conditions  of 
demand  are  beyond  his  control.  When  once  the  supply  is 
settled  and  put  on  the  market,  the  price  at  which  it  will  sell 
depends  on  the  play  of  demand.  In  this  regard,  monopoly 
value  presents  no  peculiarities.  Its  special  problems  arise  in 
so  far  as  the  monopolist  can  make  the  supply  larger  and  smaller 
at  will.  With  a  given  supply,  put  on  the  market  en  bloc,1  the 
price  will  be  the  same  whether  it  is  in  the  hands  of  a  single 
person  or  of  several  competing  persons.  There  is  some  one 
price  which  measures  its  marginal  utility,  —  some  one  price  at 
which  the  whole  can  be  sold,  and  no  more  than  the  whole,  — 
and  that  price  will  rule. 

This  proposition,  like  so  many  in  economics,  needs  to  be 
taken  broadly,  as  a  statement  of  a  tendency,  not  of  literal 
detail;  with  precisely  the  same  allowance  for  irregularity  and 
imperfect  adaptation  that  must  be  made  for  any  general  state- 
ment on  values  and  prices.  Most  men  in  active  business 
would  at  first  blush  deny  it.  They  would  say  that  a  com- 
bination or  monopoly  can  secure  a  higher  price  than  compet- 
ing persons  can,  even  for  the  same  supply.  They  know  that  a 
higher  price  can  be  obtained,  in  the  first  instance  at  least, 
from  the  middlemen,  the  wholesale  or  retail  dealers,  to  whom 

1  Sec  §  4  in  this  chapter  for  the  significance  of  this  qualification. 
199 


200  VALUE  AND  EXCHANGE 

the  monopolist  usually  makes  his  direct  sales.  When  producers 
are  competing,  these  dealers  are  very  apt  to  play  off  one  against 
another,  and  to  induce  the  shaving  of  an  offered  price  by 
threatening  to  turn  to  a  competitor.  No  doubt,  if  all  of  the 
dealers  do  this  successfully,  competition  among  them  will  tend 
to  lower  prices  in  the  end  for  the  retail  purchasers.  At  that 
final  stage,  it  will  appear  whether  the  prices  are  such  as  to 
bring  about  the  equation  of  supply  and  demand.  But  com- 
petition among  dealers,  and  especially  among  retail  dealers, 
operates  with  friction ;  and  the  lower  prices  which  competition 
among  manufacturers  causes  these  to  concede  to  dealers  may 
redound  for  a  considerable  time  to  the  dealers'  profit,  not  to 
that  of  consumers.  Conversely,  a  monopoly  may  squeeze  the 
dealers,  so  to  speak;  charge  them  higher  prices,  which  yet 
they  do  not  find  it  feasible  —  for  some  time,  at  least  —  to  pass 
on  to  consumers.  And  even  when  such  a  rise  in  prices  reaches 
consumers,  the  effect  on  their  purchases  is  not  immediate  or 
automatic.  If  indeed  the  rise  is  great,  and  the  demand  for 
the  commodity  is  elastic,  a  reduction  in  purchases  will  be 
prompt.  The  monopolist  will  find  almost  at  once  that  he  can- 
not sell  the  same  supply  at  higher  prices.  But  if  the  rise  in 
price  is  not  great,  people  will  very  possibly  continue  to  buy 
for  some  time  what  they  have  been  in  the  habit  of  buying. 
They  may  be  uneasy  and  irritated  by  the  higher  charge,  yet 
for  the  moment  may  not  adapt  themselves  to  the  new  situation 
by  curtailing  their  purchases.  The  monopolist  may  then  hold 
the  raised  price  for  a  while,  even  if  it  reaches  consumers.  Mean- 
while, in  a  growing  community,  new  consumers  may  be  added, 
or  the  old  consumers  may  get  larger  incomes.  An  increase  in 
demand  may  overtake  the  higher  price,  and  make  it  permanent ; 
and  then  it  will  seem  as  if  the  mere  fact  of  monopoly  had  caused 
prices  to  rise. 

The  position  of  middlemen  as  buffers,  easing  and  delaying 
the  pressure  of  the  forces  at  work,  appears  even  more  strongly 
in  the  case  of  producer's  goods.  As  has  already  been  said,1 

1  See  above,  Chapter  10,  §  5. 


MONOPOLY  VALUE  201 

the  play  of  demand  and  utility  is  much  modified  in  the  prices 
of  such  things,  —  iron,  copper,  timber,  wool.  The  connection 
between  the  price  ultimately  paid  for  finished  goods  by  con- 
sumers and  the  ruling  price  among  dealers  for  materials  is  often 
a  slow  and  uncertain  one.  Still  slower  is  that  between  the 
materials  for  tools,  like  iron  and  copper,  and  the  consumable 
articles  which  in  the  end  the  tools  serve  to  make.  Here  there 
is  a  possible  influence  of  monopoly  on  price  which  would  not 
appear  if  the  monopolist  sold  an  enjoyable  commodity  directly 
to  the  consumers. 

It  is  to  be  noted,  further,  that  the  first  step  taken  by  a  monop- 
olist is  usually  to  settle  his  price,  not  his  supply.  The  holder 
of  a  patent,  for  example,  will  offer  the  patented  article  at  a  given 
price;  he  will  not  usually  determine  in  advance  the  amount 
which  he  will  put  on  the  market.  If  he  finds  that,  at  the  given 
price,  he  can  sell  more  than  he  expected,  he  will  add  to  the 
supply.  If  he  finds  that  he  cannot  sell  so  much,  he  will  let 
the  stock  which  he  has  on  hand  go  off  gradually,  and  in  the 
future  will  add  to  it  slowly  and  cautiously.  In  other  words,  he 
experiments  with  the  supply  which  he  can  dispose  of  at  the  price 
fixed ;  and  perhaps,  as  time  goes  on,  lowers  or  raises  his  price, 
according  to  the  response  from  purchasers.  Probably  he  is  only 
half  conscious  that  his  control  over  price  rests  on  his  control 
over  supply;  yet  the  shrewd  business  man  is  very  rarely  in 
doubt  that  this  is  the  fundamental  condition  for  keeping  a  price 
above  the  competitive  level. 

§  2.  The  power  of  a  monopolist  over  price  being  exercised, 
then,  fundamentally  through  his  control  over  supply,  let  us 
examine  further  in  what  way  the  control  is  exercised. 

The  simplest  case  is  that  of  a  supply  which  has  cost  nothing, 
—  something  in  the  nature  of  treasure-trove.  Such  a  fixed 
supply,  if  put  on  the  market  in  toto,  will  fetch  a  given  price. 
But  the  owner  may  reason  that  a  less  supply  will  fetch  a  higher 
price.  If  the  demand  be  inelastic,  half  of  the  supply  may  fetch 
more  than  double  the  price,  and  so  yield  a  larger  gross  sum.  It 
will  then  be  in  the  interest  of  the  monopolist  to  destroy  half  the 


202  VALUE  AND  EXCHANGE 

supply,  and  put  on  the  market  only  the  remaining  half.  If  the 
demand  is  elastic,  it  will  more  probably  be  to  his  advantage  to 
put  the  whole  on  the  market.  The  price  per  unit,  to  be  sure, 
will  be  lower  than  if  only  half  were  sold,  but  not  so  much  lower 
as  to  make  the  gross  yield  less.  It  is  usually  to  the  interest  of  a 
monopolist  to  restrict  sensibly  the  supply  of  a  commodity  sub- 
ject to  inelastic  demand,  and  to  be  liberal  with  the  supply  of 
one  subject  to  elastic  demand. 

Suppose  next  that  the  supply  is  net  fortuitous,  but  is  pro- 
duced by  the  monopolist  under  the  ordinary  conditions,  with 
capital  invested,  laborers  hired,  sundry  expenses  of  production 
incurred.  Then  the  monopolist  will  aim  to  obtain  not  the  larg- 
est gross  amount,  but  the  largest  net  profit.  And  that  net  profit 
he  will  try  to  make  larger  than  the  usual  profits  of  capitalists. 
It  may  be  assumed  that  in  any  case  the  monopolist  would  be 
able  to  secure  on  his  capital,  by  investment  in  other  directions, 
interest  at  the  usual  rate ;  and  that  for  his  own  labor  of  direction 
and  superintendence  he  would  be  able  to  secure  the  reward 
usually  accruing  to  labor  of  the  same  skill  and  assiduity.  Those 
normal  gains  we  reckon  among  the  expenses  of  production,  or 
at  least  not  as  due  to  monopoly.  It  is  the  excess  above  them 
that  constitutes  monopoly  profit. 

It  is  probable  that  few  monopolists  consciously  separate  their 
gains  in  this  way.  They  rarely  distinguish  between  monopoly 
profits  proper  and  ordinary  returns  for  their  capital  and  labor. 
They  simply  rejoice  that  they  pay  dividends  at  ten  or  twenty 
per  cent,  or  are  able  to  be  munificent  in  salaries  to  themselves 
and  their  associates.  If  closely  questioned,  however,  they 
would  soon  distinguish  the  share  in  these  gains  which  is  due  to 
monopoly  alone.  It  is  that  share,  monopoly  profits  in  the  strict 
sense,  which  now  interests  us. 

If  the  monopolist  produces  his  commodity  under  the  con- 
ditions of  constant  cost,  his  calculation  of  net  profit  will  be  simple. 
Figure  9  will  illustrate  it.  The  cost  of  producing  the  com- 
modity is  there  represented  by  the  distance  from  0  to  C,  and  is 
the  same  whether  a  large  or  small  amount  of  the  commodity 


MONOPOLY  VALUE 


203 


be  produced;  it  is  OC  =  AC'  =  EC" .  The  price  at  which  any 
given  quantity  will  sell  depends  on  the  conformation  of  the 
demand  curve  DD'.  If  a  quantity  OA  is  put  on  the  market,  it 
can  all  be  sold  at  the  price  A  A ' .  The  total  cost  of  this  quantity 
is  OCC'A.  Monopoly  profit  will  then  be  indicated  by  the  area 
X 


Fio.  9. 

CPA'C'.  But  if  the  quantity  OB  is  put  on  the  market,  the 
price  must  be  lowered  to  BB',  that  being  the  price  at  which  the 
whole  quantity  OB  can  be  disposed  of.  Monopoly  profit  is  now 
the  area  CP'B'C".  If  the  first  area,  CPA'C',  is  the  larger  of  the 
two,  it  will  be  to  the  interest  of  the  monopolist  to  restrict  his 
output  to  the  quantity  OA.  But  if  the  area  CP'B'C"  is  the 
larger,  it  will  be  to  his  interest  to  enlarge  his  output  to  the 
amount  OB.  As  has  already  been  said,  the  elasticity  of  demand 
has  an  important  influence  on  the  calculations  of  the  monopolist. 
If  demand  is  elastic,  —  if  a  lowering  of  price  will  greatly  stimu- 
late consumption  and  purchases,  —  the  line  DD'  will  have  a 
gentler  slope,  and  the  quantity  which  can  be  disposed  of  at  the 


204  VALUE  AND  EXCHANGE 

price  OP'  will  be  greater  than  OB.  The  parallelograms  indicat- 
ing gross  receipts  and  monopoly  profit  will  be  longer,  and  larger 
in  area.  Under  such  conditions  it  is  probable  that  monopoly 
profit  will  be  larger  for  a  comparatively  low  price  than  for  a 
high  one. 

In  the  preceding  section  it  was  said  that  a  monopolist  might 
find  it  to  his  advantage  to  destroy  part  of  a  supply,  in  order  to 
sell  the  remainder  for  a  larger  gross  amount.  But  such  de- 
struction can  take  place  very  rarely.  Fortuitous  supplies, 
coming  into  a  monopolist's  hands  without  cost,  hardly  ever 
occur.  When  a  monopolist's  supply  is  produced,  and  costs 
something,  it  is  obviously  easier  and  cheaper  to  refrain  from  pro- 
ducing a  part  of  it  than  to  destroy  a  part  after  it  has  been  pro- 
duced. Only  from  miscalculation  or  causes  beyond  control 
(such  as  superabundance  of  crops)  may  a  monopolist  find  de- 
struction to  his  advantage.  It  seems  to  be  well  established  that 
in  the  eighteenth  century  the  Dutch  East  India  Company  at 
times  burnt  part  of  its  crop  of  cloves  in  order  to  be  able  to  sell 
the  remainder  at  prices  so  much  higher  as  to  increase  its  gross 
receipts.  Similar  destruction  would  hardly  be  ventured  in  a 
modern  community ;  fear  of  retribution  from  an  outraged 
public  opinion  would  prevent  it.1 

The  mode  in  which  a  monopolist  commonly  proceeds  in  the 
adjustment  of  supply  is  illustrated  by  the  conditions  of  diamond 
production  in  recent  years.  Virtually  all  new  diamonds  come 
from  the  mines  at  Kimberley  in  South  Africa.  These  are  under 
the  single  ownership  of  the  De  Beers  Company,  formed  by  an 
amalgamation,  under  the  guidance  of  Cecil  Rhodes,  of  a  number 
of  competing  mines.  Some  of  the  mines  are  not  worked,  and 
the  total  supply  is  intentionally  limited  to  the  amount  which 
can  be  sold  to  best  advantage.  The  demand  for  diamonds, 
after  a  certain  point,  is  highly  inelastic.  They  are  bought  chiefly 
for  purposes  of  display.  Scarcity  and  high  price  are  the  basis  of 

1  When  a  publisher  prints  a  limited  edition  of  a  book,  and  then  distributes 
the  type,  he  may  be  said  to  wipe  out  part  of  the  supply  in  order  to  sell  at  a  higher 
price  the  restricted  portion  which  he  prints. 


MONOPOLY  VALUE 


205 


their  utility;  if  very  abundant,  they  would  be  little  prized. 
Hence  it  is  clearly  to  the  advantage  of  the  De  Beers  Company  to 
curtail  production  and  limit  the  supply.1  Were  the  commodity 
one  like  copper,  with  a  very  elastic  demand,  it  might  pay  such  a 
monopolist  to  work  the  source  of  supply  to  its  utmost  capacity. 
§  3.  Suppose  now  that  the  monopolized  commodity  is  pro- 
duced, not  under  the  conditions  of  constant  cost,  but  under  those 
of  diminishing  cost  (increasing  returns).  The  calculations  of  the 
monopolist  then  become  complex.  He  must  consider  on  the 
one  hand  the  extent  to  which  price  will  fall  as  a  larger  supply  is 
put  on  the  market,  and  on  the  other  hand,  how  much  cost  will 
fall  as  more  is  produced.  The  situation  is  again  easily  illustrated 
by  a  diagram. 


1  The  De  Beers  Company  controls  95  per  cent  of  the  world's  diamond  produc- 
tion. See  G.  F.  Williams,  The  Diamond  Mines  of  South  Africa,  Vol.  I,  p.  291 ; 
Vol.  II,  p.  161. 

I  have  referred  to  the  diamond  monopoly  as  K  it  presented  a  case  of  constant 
cost.  This  is  not  probable  in  the  case  of  mines,  least  of  all  where  the  occurrence 
of  the  product  is  as  irregular  as  in  diamond  mines.  But  the  motives  that  lead 
to  a  curtailment  of  supply  are  essentially  the  same, 


206  VALUE  AND  EXCHANGE 

On  Figure  10  DD'  has  a  slight  inclination,  representing  a  very 
elastic  demand.  SS',  the  supply  curve,  has  a  steep  inclination, 
at  least  in  its  upper  range,  representing  a  very  rapid  decline  in 
cost  per  unit  as  supply  is  enlarged.  If  the  monopolist  produces 
and  puts  on  the  market  the  quantity  OA,  he  will  find  the  cost 
per  unit  to  be  AC,  and  the  total  cost  to  be  COAC.  That  supply 
will  be  sold  at  the  price  AA' ;  the  gross  receipts  will  be  OP  A' A, 
and  the  monopoly  profit  will  be  CPA'C.  If,  on  the  other  hand, 
the  quantity  produced  is  the  larger  amount  OB,  the  cost  per 
unit  will  be  only  BC',  and  the  cost  of  the  total  supply  will  be 
C'OBC'.  That  supply  can  be  sold  at  the  price  BB'.  The  gross 
receipts  will  be  ORB'B,  and  the  monopoly  profits  will  be 
C'RB'C'.  Evidently  the  monopoly  profit  will  be  much  greater 
with  the  lower  price  than  with  the  higher  price  ;  this  because  the 
conditions  assumed  are  those  of  very  elastic  demand  and  of 
rapidly  decreasing  cost.  The  less  elastic  the  demand,  and  the 
less  rapid  the  decrease  in  cost,  the  more  probable  is  it  that  the 
monopolist  will  find  it  to  his  advantage  to  limit  the  supply  and 
keep  up  the  price. 

The  reader  will  easily  see  that  a  number  of  maximum  monop- 
oly profits  and  ruling  monopoly  prices  are  possible.  To  express 
in  one  single  statement  all  the  elements  of  the  case  would  require 
mathematical  formulation.  Such  a  formulation,  however,  has 
an  appearance  of  accuracy  which  is  often  misleading ;  and  this 
is  true  even  of  a  comparatively  simple  diagram  like  that  given 
above.  Some  of  the  elements  in  the  situation  must  be  more  or 
less  a  matter  of  guess  work  for  the  monopolist ;  especially  the 
degree  of  elasticity  in  demand,  and  the  rate  of  decreasing  cost 
with  enlarged  production.  Even  in  the  case  of  a  perfectly  un- 
restrained monopoly,  —  and  such  are  very  rare,  —  monopoly 
price  is  usually  fixed  by  a  sort  of  rule  of  thumb.  Though  probably 
at  a  point  considerably  above  the  competitive  price,  it  is  not 
settled  by  any  refined  calculation  of  the  precise  point  of  maxi- 
mum profit. 

Sharply  decreasing  cost,  or  increasing  return,  is  most  likely 
to  appear  where  articles  are  newly  introduced.  At  first  these 


MONOPOLY  VALUE  207 

are  bought  and  used  in  small  amounts.  Later,  as  they  become 
familiar  and  widely  used,  they  are  produced  in  larger  quantities, 
and  the  principle  of  increasing  returns  applies.  Not  infrequently 
new  articles  are  monopolized,  being  protected  by  patent  or  copy- 
right laws.  They  then  give  a  most  apt  illustration  of  the  work- 
ing of  the  principles  here  under  consideration.  Thus,  the  Wels- 
bach  mantles  attached  to  gaslights  were  long  protected  by 
patent  in  all  advanced  countries.1  They  enabled  a  much  better 
light  to  be  had  for  a  less  expenditure  on  gas,  and  they  contami- 
nated the  air  less.  The  demand  for  them  was  highly  elastic. 
They  were  produced  much  more  cheaply  in  large  quantities. 
Hence,  though  monopolized,  they  were  sold  at  a  price  which,  per 
unit  of  product,  was  not  greatly  above  cost  price ;  none  the  less, 
on  the  enormous  quantity  which  could  be  sold,  they  yielded  mo- 
nopoly profits  very  great  in  the  aggregate. 

A  situation  essentially  similar  appears  in  the  case  of  copy- 
righted books.  Books  conform  to  the  principle  of  decreasing  cost. 
The  expense  of  typesetting  and  of  making  the  stereotype  plates  is 
the  same  whether  one  thousand  copies  be  printed  or  fifty  thousand. 
The  other  expenses  of  bookmaking  —  paper,  presswork,  binding, 
and  the  like  —  are  tolerably  uniform  per  unit,  yet  some  of  them 
show  slightly  diminishing  cost  as  more  books  are  printed  from 
the  same  plates.  On  the  whole,  the  cost  per  unit  is  much  less 
for  a  large  edition  than  for  a  small  one.  A  common  device  of 
publishers  is  to  issue  a  limited  edition,  often  with  numbered  copies, 
and  dispose  of  it  at  a  high  rate  to  collectors  and  other  persons 
who  prize  the  possession  of  a  rare  thing.  They  calculate  that  the 
profit  will  be  greater  from  a  small  edition  at  a  high  price,  than 
from  a  large  edition  at  a  low  price.  The  same  result  appears 
with  scientific  books,  which  often  appeal  to  but  a  small  circle  of 
readers  and  for  which  the  demand  is  inelastic.  The  few 
copies  printed  are  sold  at  a  comparatively  high  price  to  those 
who  desire  them.  Were  they  salable  in  large  quantities,  their 
cost  and  probably  their  price  would  be  lower.  On  the  other 
hand,  new  books  which  many  people  may  be  tempted  to 

1  This  patent  expired  in  the  United  States  in  1906. 


208  VALUE  AND  EXCHANGE 

read  —  popular  novels,  for  example  —  are  sold  at  the  outset  for 
a  lower  price,  for  they  present  the  conditions  both  of  decreasing 
cost  and  of  elastic  demand. 

It  is  obvious  that  under  conditions  of  increasing  cost  (dimin- 
ishing returns)  the  situation  of  a  monopolist  will  again  be  differ- 
ent. The  probability  of  a  sharp  limitation  of  supply  is  evi- 
dently greater  if  the  increase  of  supply  entails  greater  cost  for 
the  additional  output.  If  the  demand  be  highly  inelastic,  the 
monopolist  will  certainly  be  disposed  to  restrict  his  output  very 
much ;  for  the  price  he  can  get  will  rise  •  much  with  lessened 
supply,  while  his  expenses  will  fall.  And  even  with  an  elastic 
demand,  he  will  have  to  reckon,  not  indeed  with  rapidly  falling 
price  as  output  increases,  but  with  some  increase  in  cost.  Mo- 
nopoly, however,  with  diminishing  returns  is  probably  rare.  It 
may  appear  in  the  case  of  some  uncommon  mineral  products, 
obtained  from  a  single  source  of  supply  or  a  few  combined  sources 
(the  South  African  diamond  mines  may  present  an  example). 
On  the  whole  monopoly  conditions,  complete  or  partial,  are 
much  more  likely  to  be  found  with  commodities  produced  under 
constant  or  under  increasing  returns. 

§  4.  Monopoly  presents  another  possibility, — different  install- 
ments of  the  supply  may  be  sold  at  varying  prices.  Under  com- 
petition, one  price  prevails  throughout  the  market ;  no  one  seller 
is  allowed  by  the  others  to  get  a  higher  price.  In  the  preceding 
paragraphs  it  has  been  tacitly  assumed  that  the  same  holds  good 
under  monopoly.  But  it  does  not  necessarily  hold. 

Look,  for  example,  at  Figure  9  (p.  203)  representing  monopoly 
under  the  conditions  of  constant  cost.  The  monopolist  cannot 
but  look  with  longing  eyes  at  the  possible  profits  represented  by 
the  area  CPA'C'.  It  is  true  that  the  one  uniform  price  yield- 
ing him  the  largest  gain  may  be  the  price  OP'  (  =  BB'},  at  which 
his  monopoly  profits  are  CP'B'C".  But  may  he  not  get  in 
addition  the  extra  profit  potentially  to  be  had  on  the  quantity 
OA,  which  would  sell,  if  put  on  the  market  by  itself,  at  the  price 
AA't  May  he  not  charge  a  high  price  to  the  richer  or  more 
eager  buyers,  while  selling  at  a  lower  rate  to  those  not  able  or 
willing  to  pay  the  high  price  ? 


MONOPOLY  VALUE  209 

To  sell  directly  and  openly  at  varying  prices  to  different  pur- 
chasers is,  to  be  sure,  not  always  feasible  or  politic.  There  is  the 
possibility  of  resale  by  the  favored  purchaser.  Moreover,  the 
instinct  of  equality  or  "fair  treatment"  is  to  be  reckoned  with. 
Its  violation  arouses  a  feeling  of  resentment,  which  may  affect 
purchasers  or  lead  to  hostile  legislation.  Hence  the  monopolist, 
if  he  discriminates,  is  likely  to  disguise  his  discrimination.  But 
in  some  degree  he  will  not  infrequently  secure  from  the  upper 
strata  of  buyers  that  higher  price  which  would  otherwise  inure 
to  them  as  consumer's  surplus. 

Thus  the  monopolist  may  put  the  commodity  on  the  market  in 
installments.  He  may  sell  at  a  high  price  first  to  those  whose 
demand  is  keenest ;  and  then,  after  a  pause,  put  on  the  market 
a  further  supply  at  a  lower  price.  Substantially  this  is  often 
done  by  publishers  with  copyrighted  books,  especially  such  as 
are  reasonably  sure  to  have  a  considerable  vogue.  A  first 
edition  is  offered  at  a  comparatively  high  price.  After  a  season 
or  two,  a  much  cheaper  "popular"  edition  is  put  out,  tempting 
a  whole  army  of  buyers  for  whom  the  first  edition  was  too  ex- 
pensive. There  is,  indeed,  some  pretense  of  a  difference  between 
the  two.  The  popular  edition  is  printed  on  cheaper  paper,  has 
a  less  elaborate  binding,  or  may  be  in  paper  cover.  But  the 
difference  in  cost  between  the  two  forms  is  usually  small,  and  by 
no  means  accounts  for  the  difference  in  selling  price.  That  dif- 
ference results  in  the  main  from  the  publisher's  effort  to  tap  in 
succession  the  several  strata  of  buyers. 

Something  of  the  same  sort  happens  not  infrequently  in  the 
case  of  patented  articles.  These  may  be  sold  at  a  high  price 
for  the  first  installments  put  on  the  market,  and  at  prices  much 
reduced  as  the  great  mass  of  buyers  are  sought.  There  is,  to 
be  sure,  another  factor,  already  referred  to.  Being  patented, 
the  articles  must  be  of  a  new  sort;  since  the  law  gives  the 
monopoly,  or  patent,  only  on  the  ground  of  this  novelty.  The 
market  is  necessarily  uncertain.  The  patentee  is  likely  to  pro- 
ceed cautiously.  The  moderate  quantity  put  on  the  market 
at  the  outset  does  not  allow  the  advantages  of  large-scale  pro- 


210  VALUE  AND  EXCHANGE 

duction ;  hence,  though  price  is  high,  cost  also  is  high.  If  it 
were  certain  from  the  start  that  the  article  would  find  a  wide 
sale,  large  plant  and  elaborate  division  of  labor  might  be  ap- 
plied from  the  beginning,  great  quantities  might  be  produced, 
a  small  part  sold  at  once  at  high  prices,  the  rest  stored  away 
until  it  was  time  to  satisfy  the  demand  at  lower  prices.  But 
this  involves  risk.  Commonly,  the  earlier  installments  are  pro- 
duced and  sold  tentatively,  and  the  advantages  of  low  cost 
are  not  reaped  until  the  possibility  of  large  sales  at  low  prices 
is  proved  by  successive  experiments. 

A  direct  instance  of  discrimination  in  price  seems  to  be 
supplied  by  the  telephone.  This  is  a  monopoly  in  most  com- 
munities, and  indeed,  whether  under  private  or  public  manage- 
ment, ought  to  be  a  monopoly.  The  commodity,  or  service, 
is  not  of  a  transferable  kind;  hence  one  obstacle  to  discrimi- 
nation —  possible  resale  —  is  out  of  the  way.  Telephone  rates 
are  commonly  adjusted  on  the  basis  of  what  the  user  can  pay; 
they  are  higher  in  cities  and  in  thickly  settled  districts  than  in 
rural  districts.  Some  parts  of  the  variations  in  charges  are 
doubtless  due  to  differences  in  cost,  but  in  the  main  they  seem 
to  be  the  outcome  of  monopoly  conditions. 

A  converse  case  occurs  when  a  monopoly  charges  a  level 
rate  to  all  persons,  under  conditions  which  would  lead  com- 
peting producers  to  charge  rates  varying  according  to  cost. 
Probably  the  uniform  five-cent  fare  on  American  street  railways 
could  not  be  maintained  but  for  monopoly  conditions.  Custom, 
convenience  in  collection,  and  a  disposition  to  conciliate  the 
public,  account  here  for  the  one  rate  of  fare  which  the  monopoly 
charges.  The  most  striking  case  of  this  sort,  however,  is 
where  a  public  authority  carries  on  an  industry  as  a  monopoly. 
The  uniform  rate  of  postage  on  letters  is  to  be  explained  largely 
in  this  way.  The  two-cent  rate  is  highly  profitable  on  short 
distance  letters,  and  especially  on  letters  in  the  large  cities.  If 
competing  producers  carried  on  the  business,  some  of  them 
would  enter  this  profitable  part  of  the  field  and  carry  letters 
there  for  much  less  than  two  cents.  Private  individuals  or 


MONOPOLY  VALUE  211 

corporations  who  might  undertake  letter  service  in  outlying 
districts  of  thin  population,  especially  the  rural  districts, 
would  have  to  charge  considerably  more;  or  else  the  govern- 
ment would  have  to  do  the  work  at  a  heavy  financial  loss. 
The  existing  monopoly  enables  the  government  to  cover  the 
loss  in  one  region  from  the  profit  in  another.  The  postal 
service  is  administered  at  a  very  moderate  uniform  rate,  either 
with  profit,  as  in  European  countries,  or  at  a  comparatively 
small  loss,  as  in  the  United  States.  The  social  and  educational 
advantages  of  thus  conducting  the  service,  as  a  monopoly 
with  uniform  rates,  are  too  obvious  to  need  emphasis. 

§  5.  The  possibility  of  charging  different  prices  to  different 
purchasers  explains  the  phenomenon  of  "dumping,"  —that 
is,  the  disposal  of  commodities  in  a  foreign  country  at  one  price, 
and  to  domestic  purchasers  at  another  and  higher  price.  In 
the  absence  of  monopoly, — that  is,  if  producers  were  competing 
freely,  —  all  purchasers  would  get  commodities  at  the  same 
price.  The  producers  might,  indeed,  gain  collectively  by  selling 
part  of  the  supply  at  a  low  rate,  and  the  rest  at  a  higher.  Where 
market  conditions  are  disadvantageous,  and  where  the  total 
supply  cannot  be  sold  on  remunerative  terms,  there  is  a  strong 
inducement  to  resort  to  such  tactics.  But  no  one  producer 
will  sacrifice  himself  for  the  benefit  of  the  rest;  he  will  not 
slaughter  the  whole  or  a  part  of  his  stock  in  order  that  others 
may  gain.  If,  however,  all  were  to  carry  out  an  agreement  to 
sacrifice  each  a  specified  share  of  his  supply,  reserving  the 
remainder  for  higher  prices,  the  object  might  conceivably  be 
accomplished.  Here,  to  be  sure,  there  is  this  obstacle :  a  pos- 
sibility that  the  favored  purchaser  may  resell  to  those  from 
whom  it  is  proposed  to  exact  the  higher  price.  But  if  the 
favored  purchaser  is  a  foreigner,  and  if  a  heavy  duty  on  imports 
prevents  him  from  sending  back  the  "dumped"  commodity  to 
the  domestic  market,  the  obstacle  is  removed.  The  domestic 
price  can  then  be  kept  higher,  and  the  gain  from  this  source 
may  outweigh  the  loss  on  the  dumped  sales  to  foreigners; 
especially  if  the  commodity  be  one  for  which  the  demand  is 


212  VALUE  AND  EXCHANGE 

inelastic  and  of  which  an  increased  supply  on  the  domestic 
market  would  greatly  depress  the  price.  If  the  operation  be 
carried  on  by  a  compact  monopoly,  it  is  possible  that  the 
foreign  sales  themselves  will  be  at  remunerative  rates,  and  that 
the  higher  domestic  price  will  yield  monopoly  profits  still  fur- 
ther enhanced. 

The  more  complete  the  monopoly,  the  more  likely  will  be 
inequalities  in  the  nature  of  "dumping."  Even  in  cases  of 
halfway  monopoly  or  temporary  monopoly,  something  of  the 
sort  may  happen,  though  the  discriminations  will  be  less  striking 
and  less  continued.  Any  producer  or  vendor  of  a  "specialty" 
—  a  particular  brand,  an  unusual  commodity  —  is  apt  to  be 
for  a  time  in  a  position  of  semi-monopoly.  So  far  as  he  con- 
trols the  given  article,  he  may  find  it  advantageous  to  get  rid 
of  part  of  his  supply  in  a  foreign  country,  or  in  any  out-of-the- 
way  region,  in  order  not  to  "spoil"  his  domestic  market. 
Where  control  of  the  market  rests  only  on  good  will,  or  on 
established  plant  and  reputation,  the  extent  to  which  dumping 
can  be  carried  is  obviously  less  than  in  the  case  of  a  firm  and 
enduring  monopoly.  Where,  on  the  other  hand,  many  pro- 
ducers are  steadily  competing  in  the  sale  of  a  staple  commodity, 
dumping  will  not  arise  at  all. 

§  6.  Complete  and  unqualified  monopoly  is  rare.  Hence 
too  much  stress  should  not  be  laid  on  the  theory  of  monopoly 
price  in  explaining  the  phenomena  of  actual  life. 

A  monopoly  exercised  by  a  government  for  fiscal  reasons  gives 
perhaps  the  best  chance  of  exacting  the  full  monopoly  profit. 
When  the  Khedive  of  Egypt,  in  the  days  before  the  English 
occupation,  maintained  a  monopoly  of  the  salt  trade,  he  prob- 
ably squeezed  out  of  it  remorselessly  all  that  could  be  exacted 
from  his  unfortunate  subjects.  But  generally  fiscal  monopolies 
do  not  exercise  their  power  to  the  utmost.  They  are  not  un- 
common in  civilized  countries,  being  simply  a  method  of 
securing  public  revenue  by  monopoly  management  instead  of 
by  taxes.  Such  are  the  tobacco  and  salt  monopolies  in  Austria 
and  Italy,  the  tobacco  monopoly  in  France,  the  spirit  monopo- 


MONOPOLY  VALUE  213 

lies  in  Switzerland  and  Russia.  These  are  rarely  exploited  up 
to  their  maximum  yield.  A  given  net  revenue,  varying  accord- 
ing to  the  financial  needs  of  the  several  states,  is  sought,  and 
the  adjustment  of  supply  and  of  prices  is  pressed  no  further. 

Patented  and  copyrighted  articles,  again,  seem  to  fulfill  the 
conditions  of  perfect  monopoly;  the  law  forbids  competition 
once  for  all.  But  the  holder  of  such  a  monopoly  must  reckon 
with  the  competition  of  more  or  less  available  substitutes,  and 
thus  is  compelled  to  abate  his  prices  and  enlarge  his  supplies 
more  than  he  would  otherwise  do.  Copyrighted  books,  for 
example,  must  meet  the  competition  of  other  copyrighted 
books  of  a  similar  kind,  not  to  mention  those  on  which  the 
copyright  has  expired.  A  first-rate  textbook  yields  a  good 
monopoly  profit,  sometimes  a  very  high  one.  Yet  if  the  price 
be  put  too  high,  others,  little  worse,  can  be  used  in  its  place. 
The  gain  from  a  copyrighted  or  patented  article  often  arises 
not  so  much  from  selling  it  at  a  higher  price  than  others  of  a 
similar  sort,  as  from  selling  much  more  of  it  at  about  the  same 
price.  This  gain  is  obviously  the  greater  if  the  conditions  of 
production  are  those  of  decreasing  cost. 

In  other  cases,  also,  of  real  or  apparent  or  halfway  monopoly, 
there  are  commonly  checks.  Many  so-called  monopolies  lack 
a  legal  basis  and  even  a  solid  industrial  basis.  Such  is  the 
case  with  most  of  the  "trusts"  which  have  been  formed  by 
horizontal  combination.  They  must  be  ever  on  the  watch 
against  competitors,  and  very  few,  if  any,  are  in  a  position  to 
exercise  unrestrained  monopoly  power.  Others,  again,  though 
more  securely  founded,  must  be  on  their  guard  against  regula- 
tion or  displacement  by  public  authority.  Such  are  the  so- 
called  "public  service"  industries, — the  railway,  the  street  rail- 
way, the  telegraph,  the  telephone,  the  gas  companies.  Both 
of  these  sorts  of  cases,  so  important  in  modern  industry,  will 
engage  our  attention  as  we  proceed.  Here  it  suffices  to  note 
that  the  monopoly  is  in  one  way  or  another  qualified. 

Finally,  the  dullness  or  torpor  of  a  monopolist  must  be 
reckoned  with.  The  strict  reasoning  of  the  theory  of  monopoly 


214  VALUE  AND  EXCHANGE 

price  assumes  him  to  press  his  advantage  shrewdly  and  to  the 
utmost.  He  may  do  nothing  of  the  kind.  The  spur  of  com- 
petition —  the  one  force  which  more  than  any  other  stimulates 
enterprise  and  business  intelligence  —  is  lacking.  The  secure 
monopolist  is  likely  to  be  content  with  a  good  comfortable 
profit,  and  to  let  well  enough  alone.  It  may  happen,  indeed, 
that  another  and  shrewder  person  will  see  the  possibilities,  will 
buy  out  the  inert  possessor,  and  proceed  to  manage  the  affair 
with  more  vigor  and  profit.  Such  has  been  not  infrequently 
the  course  of  events  in  the  public  service  monopolies  of  modern 
times,  especially  in  those  whose  possibilities  of  profit  have 
been  connected  with  changes  in  the  arts  and  the  rapid  growth 
of  great  cities.  But  this  is  not  a  matter  on  which  prediction 
can  be  ventured.  The  actual  working  of  monopoly,  while  it 
conforms  more  or  less  to  the  theoretical  analysis,  is  often  highly 
uncertain  and  irregular. 

§  7.  It  remains  to  say  a  word  about  one  form  of  monopoly 
which  frequently  comes  into  public  notice,  the  "corner."  This 
word  usually  implies  not  that  the  sources  of  production  have 
come  permanently  under  monopoly  control,  but  that  the  avail- 
able supply  has  been  got  for  the  time  into  a  single  hand.  Re- 
currently, persons  of  speculative  bent  try  their  hands  at  this 
operation,  buying  up  the  whole  supply  of  an  article,  and  then 
selling  it,  if  possible,  at  a  large  profit. 

So  far  as  the  ordinary  course  of  market  prices  is  concerned, 
mere  cornering  has  no  effect.  If  supply  remains  the  same, 
price  to  consumers  will  not  be  more  or  less  because  an  article  is 
in  single  hands.  Yet  the  cornerer  may  make  money.  If  so, 
this  is  because  he  has  foreseen  more  quickly  or  more  shrewdly 
than  others  a  shortage  in  the  seasonal  supply.  By  buying  the 
whole  of  it  at  moderate  prices  from  producers  or  dealers  less 
shrewd,  he  may  profit  by  an  advance.  But  that  advance  was 
certain  to  come  sooner  or  later.  The  profit  is  not  obtained  at 
the  expense  of  consumers.  The  question  is  simply  which  set 
of  producers  or  middlemen  will  accurately  gauge  the  market 
price  of  the  season  and  profit  accordingly.  This  is  especially 


MONOPOLY  VALUE  215 

true  of  articles  that  are  in  consumable  form,  or  very  nearly  in 
consumable  form.  Such  is  ice,  the  supply  of  which,  in  regions 
depending  on  natural  (winter-frozen)  ice,  is  absolutely  fixed  by 
the  contingencies  of  the  weather ;  or  a  vegetable  like  tomatoes, 
the  crop  of  which,  for  canning  purposes,  has  sometimes  been 
bought  out  by  speculators  engineering  a  corner.  The  price  of 
these  things  is  settled  with  much  precision  by  the  play  of 
demand  and  supply,  i.e.  by  marginal  utility,  and  it  matters 
not  to  the  consumer  whether  that  supply  be  in  a  single  hand 
or  not. 

In  the  case  of  producer's  goods,  such  as  metals  and  raw 
materials,  the  possible  effect  on  prices  from  a  corner  is  greater, 
for  the  reasons  already  indicated.  Provided  the  corner  is 
rigorous,  —  provided  all  the  available  supplies  and  avenues  of 
supply  are  effectively  controlled,  —  there  is  at  least  a  possi- 
bility that  middlemen  and  producers  who  are  committed  to 
operations  in  which  the  raw  materials  are  needed,  will  be  mulcted 
for  a  higher  price  than  would  rule  without  the  corner. 

Quite  another  situation  appears  when  the  persons  against 
whose  purses  the  corner  is  aimed  are  not  the  consumers,  but 
other  dealers  and  speculators,  and  especially  the  speculators 
who  have  been  buying  or  selling  for  future  delivery.  Most 
speculators  ars  simply  betting  on  future  prices.  They  are 
doing  so,  in  the  majority  of  cases,  with  incomplete  or  ill-inter- 
preted information.  A  speculative  corner  is  commonly  directed 
against  those  who  have  sold  for  future  delivery,  —  that  is, 
those  who  have  agreed  to  sell  for  a  given  price,  at  a  fixed  date 
in  the  future,  something  which  they  do  not  own.  A  shrewd 
and  daring  person,  or  even  one  not  shrewd  but  only  daring, 
who  believes  that  many  persons  have  oversold  for  future 
delivery,  may  try  to  buy  up  the  whole  supply  available  at  the 
stipulated  date.  If  he  succeeds,  he  may  then  dictate  the  price 
at  which  they  must  buy  from  him,  in  order  to  keep  their  en- 
gagements; and  the  difference  between  that  price  and  the 
price  he  has  paid  for  his  purchases  makes  the  profit  of  the 
corner.  Evidently  the  persons  who  are  directly  affected  are 


216  VALUE  AND  EXCHANGE 

not  the  consumers,  but  only  other  .dealers  and  speculators. 
In  so  far,  it  is  a  case  of  diamond  cut  diamond. 

Yet  the  consuming  public  is  by  no  means  without  its  con- 
cern in  these  speculative  corners.  Some  of  its  purchases  may 
be  of  a  sort  that  cannot  be  postponed,  and  must  be  made  at 
the  ruling  market  price.  This  buying  comes  from  those  more 
eager  or  necessitous  persons,  who  would  ordinarily  get  the 
article  at  the  normal  market  price,  and  would  secure  a  con- 
sumer's surplus.  During  the  crucial  period  of  a  corner  —  say 
during  the  month  of  May,  if  wheat  for  May  delivery  is  the 
bone  of  contention  —  wheat  will  sell  at  an  artificially  high 
price.  The  cornerer  is  intent  on  buying  every  part  of  supply 
that  comes  to  market,  to  prevent  his  opponents  from  getting 
the  means  of  satisfying  their  contracts.  These  opponents,  in 
turn,  are  under  no  less  pressure  to  secure  the  supplies.  Until 
the  struggle  is  over, — until  either  the  corner  "bursts"  because 
the  cornerer  finds  he  cannot  possibly  buy  the  entire  supply, 
or  else  the  "short  sellers"  acknowledge  themselves  defeated 
and  "settle"  with  their  opponent, — so  long  the  market  price 
is  high,  and  those  who  are  under  the  necessity  of  buying  for 
bona  fide  use  must  pay  accordingly.  When  the  struggle  is  over, 
price  goes  back  suddenly  to  the  normal  level  for  the  season,  or 
even  below  that  level.  Most  consumers  are  no  worse  off  than 
before,  and  sometimes  are  better  off,  in  consequence  of  the 
rapid  disposal  of  supplies  long  withheld  from  the  market. 

Successful  corners  are  rare.  Usually  those  who  attempt 
them  underestimate  the  supply  and  overstrain  their  credit. 
When  the  bidding  of  the  contending  speculators  raises  prices, 
all  sorts  of  unexpected  nooks  and  crannies  prove  to  have  scraps 
of  supply  that  are  hurried  on  the  market  to  take  advantage 
of  the  golden  opportunity;  while  the  usual  consumption  is 
curtailed,  and  so  far  leaves  more  of  the  usual  supply  available. 
In  order  to  hold  the  corner,  enormous  sums  must  be  provided, 
always  by  borrowing  on  a  vast  scale,  with  hypothecation  of 
what  is  already  controlled ;  and  the  insistence  of  a  large  creditor 
may  precipitate  a  collapse.  Where  the  commodity  is  not,  like 


MONOPOLY  VALUE  217 

agricultural  products,  the  subject  of  seasonal  cultivation,  but  is 
continuously  produced,  the  difficulties  in  the  way  of  a  corner 
are  even  greater.  In  1887-1888  a  noted  attempt  was  made 
by  a  group  of  French  speculators,  headed  by  one  Secretan, 
to  corner  copper.  At  once  copper  poured  in  from  every  part 
of  the  world,  and  all  sorts  of  unknown  or  half-worked  mines 
added  to  the  product.  The  corner,  after  keeping  up  prices  for 
many  months,  and  causing  disturbance  and  expense  to  those 
whose  purchases  had  of  necessity  to  be  made  during  its  opera- 
tion, finally  failed  disastrously ;  its  promoter  was  led  to  suicide, 
and  a  great  French  bank  which  had  lent  him  large  funds  was 
compelled  to  suspend  payments./ 


CHAPTER  16 
JOINT  COST  AND  JOINT  DEMAND 

§  1.  Not  infrequently  commodities  are  produced  at  joint  cost ; 
the  same  operations  which  turn  out  one  in  the  group  turn  out 
another  also.  Such  are  mutton  and  wool ;  beef,  hides,  and  horn ; 
copper,  gold,  silver  from  ores  containing  these  diverse  metals ; 
cotton  fiber  and  cotton  seed.  Commodities  produced  at  joint 
cost  are  of  interest  to  us  because  of  the  peculiar  problems  of 
price  which  they  present. 

A  perfect  example  of  joint  production  is  that  of  cotton  fiber 
and  cotton  seed.  To  make  the  fiber  marketable,  the  seed  must 
be  separated  from  it ;  all  the  expenses  of  cultivation  and  of  gin- 
ning are  necessarily  incurred  for  the  two  together.  But  the 
prices  per  pound  at  which  fiber  and  seed  sell  are  very  different. 
For  every  pound  of  lint  (fiber)  there  are  about  two  pounds  of 
seed.  At  the  prices  of  recent  years  (1903-1908)  the  fiber  has 
sold  at  about  ten  cents  a  pound ;  the  seed  at  about  one  half  cent 
a  pound.  It  may  be  assumed,  with  little  divergence  from  the 
facts,  that  cotton  is  produced  under  conditions  of  competition, 
and  that  there  is  a  large  margin  at  which  the  cost  is  practically 
constant.  Fiber  and  seed  between  them  therefore  sell,  taking 
their  average  prices  over  a  series  of  years,  for  what  it  costs  to 
produce  them.  But  the  apportionment  of  this  total  price  be- 
tween the  two  joint  products  depends  on  the  relative  demand 
for  them,  or,  in  the  terms  which  we  have  learned  to  use,  on  their 
marginal  utility.  The  marginal  utility  of  the  cotton  fiber  from 
a  given  crop  is  much  greater  than  the  marginal  utility  of  the 
seed  produced  along  with  it ;  hence  cotton  sells  at  a  much  higher 
price  per  pound. 

It  follows  that  an  increase  of  demand  for  a  commodity  which  is 
produced  jointly  with  another,  may  cause  a  fall  in  the  price  of 

218 


JOINT  COST  AND  JOINT  DEMAND  219 

that  other.  If  the  demand  for  cotton  increases,  its  price  will 
rise.  This  will  not  directly  affect  the  price  of  seed,  for  which  the 
supply  and  the  conditions  of  demand  remain  the  same.  But 
the  higher  price  of  cotton  is  likely  to  stimulate  production,  and 
more  both  of  fiber  and  of  seed  will  be  brought  to  market.  The 
conditions  of  demand  remaining  unchanged  for  seed,  its  price 
must  fall  as  supply  is  enlarged.  Production  will  be  increased 
until,  in  the  end,  the  two  between  them  will  again  sell  for  their 
joint  expenses  of  production.  But  as  the  seed  now  sells  at  a 
lower  price,  the  fiber  must  sell  at  a  somewhat  higher  price ;  and 
the  definitive  outcome  of  the  greater  demand  for  fiber  will  thus 
be  a  larger  output  of  both  constituents.  It  will  cause  a  higher 
price  for  the  one  and  yet  entail  a  lower  price  for  the  other.  The 
opposite  effect  would  follow  if  demand  for  one  of  the  articles 
should  become  not  greater,  but  less. 

In  most  instances  of  joint  cost,  the  situation  is  not  so  simple  as 
this ;  for  usually  each  article  entails  some  separate  items  of  ex- 
pense. It  is  rare  that,  as  with  cotton  fiber  and  cotton  seed,  all 
the  expenses  are  incurred,  to  the  very  last  stage,  jointly  for  the 
two.  The  common  case  is  more  like  that  of  wool  and  mutton  ; 
though  produced  in  the  main  at  j  oint  cost,  each  brings  some  special 
expenses  of  its  own.  The  wool  must  be  sheared;  the  sheep 
must  be  slaughtered  and  dressed  for  mutton.  Wool  and  meat 
must  each  sell  for  at  least  the  special  cost  connected  with  them, 
so  a  minimum  price  is  set.  In  what  proportion  the  remaining 
(joint)  cost  will  be  secured  from  the  two  will  then  depend  on  the 
play  of  demand,  as  in  the  simpler  case  of  cotton  fiber  and  seed. 

The  phrase  "by-products"  is  often  applied  to  denote  some 
of  the  commodities  produced  at  joint  cost.  When  one  of 
them  habitually  sells  at  a  much  lower  price  than  the  other,  it  is 
spoken  of  as  a  by-product ;  or  when  a  material  for  which  no  use 
has  been  known,  comes  to  be  utilized  and  to  have  a  market  value, 
it  is  so  described.  Both  reasons  explain  why  cotton  seed  is  com- 
monly spoken  of  as  a  by-product,  not,  as  in  strictness  it  should 
be,  as  a  joint  product.  One  of  the  most  striking  instances  of  joint 
cost  is  in  the  utilization  of  the  various  parts  of  slaughtered  ani- 


220  VALUE  AND  EXCHANGE 

mals.  The  hide,  the  bristles,  the  bones,  the  horns,  the  hoofs, 
the  blood,  the  various  organs,  all  are  turned  to  some  sort  of  use, 
—  usually  with  items  of  special  cost  pertaining  to  each.  As 
the  meat  is  the  most  important  and  familiar  product,  the 
others  are  commonly  called  by-products. 

The  advance  in  the  arts  of  production,  especially  under  the 
influence  of  chemical  science,  has  led  to  the  utilization  of  many 
materials  previously  wasted,  and  so  has  made  the  principle  of 
joint  cost  of  wider  and  wider  application.  Wool,  produced  at 
joint  cost  with  mutton,  further  illustrates  also  this  aspect  of 
the  principle.  As  wool  comes  from  the  sheep's  back,  it  contains 
much  fatty  matter,  which  must  be  got  rid  of  before  the  fiber  can 
be  used  for  textile  purposes.  This  matter,  formerly  waste,  has 
in  recent  times  been  extracted,  in  some  degree  refined,  and  has 
proved  useful  in  treating  leather  and  for  other  purposes.  Simi- 
larly, cotton  seed,  itself  a  joint  product,  supplies  not  only  the 
oil  pressed  out  of  it  (and  that  oil  of  various  grades,  serviceable  for 
various  purposes),  but  also  the  oil  cake  remaining  after  extrac- 
tion, which  is  used  as  food  for  cattle.  The  slag  which  comes  to 
the  surface  of  the  molten  matter  in  a  pig-iron  furnace,  and  of 
which  vast  quantities  formerly  accumulated  near  the  furnaces 
(some  parts  being  perhaps  turned  to  account  locally  as  ballast 
under  railway  ties),  has  lately  been  used  as  a  material  in  the 
manufacture  of  cement.1  Coal  tar,  one  of  the  by-products 
from  the  making  of  gas  and  coke,  has  been  found  by  chemistry 
to  contain  the  materials  for  cheap  and  effective  dyestuffs,  and 
also  for  important  drugs.  The  crude  oil  which  comes  from  the 
coal-bearing  strata,  and  which  has  formed  so  wonderful  an  ad- 
dition to  man's  resources  during  the  last  half  century,  is  the 
basis  of  a  number  of  products,  having  partly  joint  cost  and  partly 
special  cost,  —  kerosene  (illuminating  oil),  naphtha,  gasoline, 
lubricating  oil,  dyes,  paraffin  and  candles,  vaseline. 

For  the  utilization  of  some  joint  products  a  large  plant  is 
indispensable ;  as  in  the  case  of  wool  grease  or  coal  oil  prod- 

1  In  Germany  the  slag  left  by  the  Thomas  and  other  basic  processes  is  the 
most  important  source  of  supply  of  phosphorus  used  as  fertilizer. 


JOINT  COST  AND  JOINT  DEMAND  221 

ucts.  In  so  far,  the  advance  of  the  arts  has  promoted  the 
growth  of  large-scale  production,  and  so  has  intensified  the 
social  problems  which  arise  from  it.  Large-scale  production, 
in  turn,  may  lead  to  monopoly,  or  largely  facilitate  it.  Then 
another  complication  appears.  Either  monopoly  alone  or  joint 
cost  alone  entails  consequences  for  value  which  diverge  far 
from  the  simpler  cases.  When  the  two  are  combined,  a 
variety  of  interacting  forces  must  be  considered, — joint  and 
separate  cost,  marginal  utility  and  elasticity  of  demand,  mo- 
nopoly and  maximum  profit,  and  the  effects  upon  monopoly 
of  possible  competition,  of  public  opinion  and  public  regula- 
tion, and  of  inert  management.  The  Standard  Oil  Company 
in  the  United  States  illustrates  all  these  complications.  It 
has  had  a  more  or  less  effective  monopoly,  due  to  various 
causes,  among  which  large-scale  production  and  the  utilization 
of  joint  products  have  played  their  part;  and  these  various 
joint  products  have  been  marketed  at  prices  influenced  by  all 
the  factors  mentioned  in  our  discussion  of  monopoly,  except 
probably  that  of  inert  management. 

Whenever  a  very  large  fixed  capital  is  used  not  for  a  single 
purpose,  but  for  varied  purposes,  the  influence  of  the  principle 
of  joint  cost  shows  itself.  Of  this  the  most  striking  instance 
appears  in  the  adjustment  of  railway  rates  —  a  case,  however, 
so  complex  that  its  consideration  is  best  postponed  to  a  later 
chapter.1  Where  a  large  plant  is  used  for  producing  one 
homogeneous  commodity,  —  say  steel  rails  or  plain  cotton  cloth, 
—  the  peculiar  effects  of  joint  cost  cannot,  of  course,  appear. 
True,  if  such  a  plant,  or  combination  of  plants,  has  a  monopoly 
or  semi-monopoly,  there  may  be  varying  prices  for  different 
portions  of  the  one  homogeneous  product;  there  may  be 
"dumping,"  as  in  the  case  of  steel  rails.2  But  this  is  a  very 
different  phenomenon  from  that  of  value  under  joint  cost. 

§  2.  A  different  case  from  joint  cost  is  joint  demand,  where 
what  is  wanted  is  not  a  single  article,  but  a  combination  of 

1  See  Book  VII,  Chapter  60,  especially  §  3. 
*  See  above,  Chapter  15,  §§4,  5. 


222  VALUE  AND  EXCHANGE 

articles.  Thus  a  demand  for  dwellings  is  a  demand  for  the 
completed  accommodation.  The  purchaser  is  indifferent  to  the 
prices  for  brick,  wood,  glass,  hardware ;  all  he  looks  for  is  the 
house  which  combines  these  various  materials. 

If  we  suppose  an  increase  in  the  demand  for  houses  in  a  given 
district,  and  a  rise  in  their  prices,  the  change  will  be  reflected  in 
a  rise  in  the  prices  of  the  several  materials.  If  the  materials 
were  used  solely  for  the  reconstruction  of  houses,  and  if  they 
were  put  on  the  market  under  the  same  conditions,  —  all 
equally  limited  in  supply,  or  all  equally  extensible  in  supply,  - 
there  would  be  no  reason  for  expecting  a  greater  rise  in  price 
for  one  than  for  the  others.  But  the  conditions  of  supply,  as  of 
demand,  are  likely  to  be  different  for  the  several  constituents. 
Some  may  be  easily  obtainable  in  unlimited  quantities  at  short 
notice ;  some  may  be  temporarily  or  permanently  limited.  So 
far  as  any  constituent  is  solely  devoted  to  the  given  purpose 
and  is  limited  in  supply,  so  far  is  it  likely  to  be  peculiarly 
affected  by  the  changes  in  demand  for  the  joint  product. 
Those  constituents  which  serve  other  purposes  also,  and  hence 
are  on  the  market  for  miscellaneous  sale,  will  be  diverted 
toward  the  joint  product  by  the  increase  in  price;  enlarging 
supply  here  will  check  in  some  degree  the  rise  in  price.  If 
the  supply  of  any  constituent  be  unlimited  and  easily  ex- 
tensible at  constant  cost,  its  price  will  not  rise  at  all.  Supply 
will  promptly  respond  to  the  new  demand,  and  the  effect  of 
that  demand  will  appear  solely  with  the  other  constituents. 
And  if  all  the  constituents  except  one  be  easily  procured  in 
larger  quantities,  and  if  their  supplies  thus  respond  quickly  to  an 
increased  demand,  that  exceptional  constituent  will  get  the  full 
benefit  of  the  increase  in  price. 

The  different  kinds  of  labor  needed  in  building  operations,  as 
well  as  the  different  kinds  of  materials,  illustrate  the  working 
of  joint  demand.  A  demand  for  houses  and  business  premises 
means  a  demand  for  all  kinds  of  workmen,  — for  unskilled  laborers, 
for  bricklayers,  masons,  and  carpenters,  for  plumbers  and  elec- 
tricians, and  (in  the  case  of  high  structures  in  American  cities) , 


JOINT  COST  AND  JOINT  DEMAND  223 

for  ironworkers.  Some  of  these  occupations  are  so  widespread 
that  an  increased  demand  for  a  particular  kind  of  labor  in  any  one 
place  easily  draws  an  increased  supply.  This  is  most  obviously 
true  of  ordinary  manual  labor,  —  plain  pick  and  shovel  work. 
More  of  it  can  usually  be  got  with  little  difficulty  from  other 
places.  With  the  rougher  kinds  of  carpenter's  work  the  situa- 
tion is  similar.  But  it  is  different  with  the  highly  skilled  trades, 
and  with  those  to  which  access  is  fettered  by  trade-union  re- 
striction. Here  it  is  more  difficult  to  add  to  the  labor  supply. 
Hence  increased  activity  in  building  may  have  the  effect  of 
very  greatly  raising  the  wages  of  the  workmen  in  these  groups, 
while  bringing  comparatively  little  change  for  the  others. 
Such  a  result  has  in  recent  years  appeared  frequently  in  Ameri- 
can cities,  strikingly  so  in  New  York.  The  rapid  growth  in 
urban  population,  combined  with  great  improvements  in  build- 
ing methods,  has  brought  about  astonishing  activity  in  adding 
to  and  in  remodeling  dwellings  and  business  premises.  Cer- 
tain kinds  of  laborers,  not  easily  increased  in  supply  by  recruiting 
from  other  occupations  or  from  other  places,  have  been  in  in- 
sistent demand, — such  as  plumbers,  tile  workers,  electrical  work- 
ers, housesmiths  (i.e.  structural  ironworkers).  These  have 
felt  more  than  the  others  the  demand  for  the  joint  product,  and 
have  secured  extraordinarily  high  wages.  Artificial  restriction 
of  the  supply  by  trade-union  regulation  has  played  no  small  part 
in  securing  for  them  an  exceptionally  larger  share  of  the  possi- 
ble gain. 

Ordinarily,  joint  demand  has  not  the  same  sort  of  permanent 
effect  on  value  that  joint  supply  has.  In  the  long  run,  the  con- 
ditions of  supply  are  the  more  important  in  affecting  value. 
Though  it  is  true,  as  appears  most  strikingly  in  the  cases  of  increas- 
ing cost  and  of  monopoly  value,  that  there  is  a  constant  inter- 
action of  supply  and  demand,  the  dominant  forces  for  most  com- 
modities are  those  of  supply.  Where  an  increased  joint  demand 
affects  most  strongly  some  one  commodity  or  some  one  kind  of 
labor,  because  that  happens  to  be  the  constituent  whose  supply 
is  least  easily  extensible,  there  is  none  the  less  likely  to  be  an 


224  VALUE  AND  EXCHANGE 

increase  in  its  supply.  A  readjustment  of  value  takes  place  of 
the  same  sort  as  would  have  taken  place  if  the  demand  had  been 
not  joint,  but  solely  and  separately  for  this  one  thing.  If  more 
brick  is  wanted,  more  will  be  produced ;  and  an  increased  de- 
mand for  houses,  though  it  may  for  the  moment  raise  the  price  of 
brick,  will  not  do  so  permanently.  But  the  situation  is  different 
with  joint  cost ;  an  increase  in  the  demand  for  cotton  fiber  may 
have  a  permanent  effect  in  lowering  the  price  of  cotton  seed. 
The  immediate  effect  of  an  increase  of  demand  is  usually  greater 
in  case  of  joint  demand;  but  the  ultimate  effect  is  usually 
greater  in  case  of  joint  supply. 

REFERENCES  ON  BOOK  II 

Easily  the  first  and  most  valuable  book  to  be  consulted  on  the 
theory  of  value  is  A.  Marshall,  Principles  of  Economics  (6th  ed., 
1910),  especially  Books  III,  IV,  V.  An  admirable  introductory  sketch 
is  in  T.  N.  Carver,  Distribution  of  Wealth,  Chapter  I ;  another  excellent 
compact  statement  is  in  I.  Fisher,  Elementary  Principles  of  Economics, 
chs.  XV-XVIII.  On  the  play  of  utility,  see  P.  H.  Wickstead,  The 
Common  Sense  of  Political  Economy  (1910) ;  Chapter  II  of  Book  I  and 
Chapter  III  of  Book  II  are  valuable  supplements  to  Marshall's  dis- 
cussion of  consumer's  surplus.  Compare  also  M.  Pantaleoni,  Pure 
Economics  (English  translation,  1898),  Part  II. 

On  speculation,  consult  H.  C.  Emery,  Speculation  in  the  Stock  and 
Produce  Exchanges  of  the  United  States  (1896). 

The  so-called  Austrian  theory  of  value,  in  which  stress  is  laid  on 
utility  as  dominating  value,  is  set  forth  most  fully  in  F.  Wieser,  Natural 
Value  (English  translation,  1893).  A  more  compact  statement  is  in 
Bohm-Bawerk,  Positive  Theory  of  Capital  (English  translation,  1891), 
Books  III  and  IV. 


BOOK  III 

MONEY  AND  THE   MECHANISM  OF  EXCHANGE 


CHAPTER  17 
THE  PRECIOUS  METALS.    COINAGE 

§  1.  We  have  already  considered  the  part  which  money  plays 
in  the  division  of  labor.1  It  is  the  medium  by  which  exchanges 
are  effected,  and  by  which  the  consequences  of  the  division  of 
labor  are  worked  out.  It  is  the  medium,  too,  in  which  the  rela- 
tive values  of  commodities  are  expressed.  At  any  given  time, 
the  price  of  a  commodity  registers  its  value.  If  iron  sells  for  one 
cent  a  pound,  and  copper  sells  for  ten  cents  a  pound,  their  rela- 
tive values  are  as  one  to  ten.  If  the  price  of  copper  rises  to 
twenty  cents,  iron  remaining  as  before,  their  relative  values 
become  as  one  to  twenty.  But  if  iron  sells  for  two  cents,  and 
copper  for  twenty,  their  values  remain  as  one  to  ten ;  and 
what  has  happened  is  a  change  in  their  value  relatively  to  the 
cents.  A  rise  in  both  prices  has  taken  place,  which  means  a  fall 
in  the  purchasing  power  of  money ;  that  is,  a  fall  in  its  value. 
Thus  money,  though  an  accurate  measure  at  any  given  time,  is  by 
no  means  necessarily  an  accurate  measure  for  different  times. 
The  most  difficult  monetary  problems  are  those  concerning  the 
variations  in  its  own  value,  that  is,  concerning  the  fluctuations 
in  the  general  range  of  prices. 

We  have  seen  also  that,  while  any  commodity  that  is  in 
general  demand  may  serve  the  purposes  of  a  medium  of  ex- 
change, the  most  important  by  far  have  been  gold  and  silver. 
Throughout  most  of  the  period  over  which  the  historical  record 
extends,  they  have  been  the  main  constituents  of  the  circulat- 
ing medium.  During  the  last  century,  they  have  been  sup- 
plemented to  a  high  degree  by  paper  substitutes  or  equivalents, 
and  monetary  conditions  have  been  by  this  process  profoundly 

1  See  Book  II,  Chapter  8. 
227 


228   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

affected.  But  specie 1  is  still,  and  bids  fair  long  to  remain,  the 
basis  of  the  medium  of  exchange  for  all  advanced  countries. 
We  can  best  begin  the  discussion  of  monetary  questions  by 
treating  them  as  if  specie  were  the  sole  constituent  of  the 
medium  of  exchange ;  introducing  thereafter  the  several  quali- 
fications which  arise  from  the  use  of  paper  money  and  of  the 
complex  credit  instruments. 

§  2.  Historically,  the  chief  reason  why  gold  and  silver  be- 
came the  money  metals  was  that  they  satisfied  the  craving  for 
adornment.  Things  that  minister  to  the  deep-rooted  love  of 
display  are  in  unfailing  demand ;  and  any  commodity  that  is  in 
unfailing  demand  may  perform  passably  the  functions  of  a 
medium  of  exchange  Hence  the  wide  variety  of  things  that 
have  so  served,  —  cattle,  grain,  salt,  furs,  tobacco,  and  what 
not.  It  is  the  luster  and  sheen  of  gold  and  silver  that  caused 
them  to  be  highly  prized  in  the  early  stages  of  civilization, 
when  other  ways  of  producing  these  effects  were  not  known. 
The  glitter  of  the  bauble  is  the  origin  of  the  monetary  use  of 
the  precious  metals;  precisely  as  glass  beads  and  scarlet  cloth 
are  serviceable  for  barter  by  explorers  who  push  into  those 
regions  (now  few)  where  savagery  is  still  unaffected  by  the 
conventional  ways  of  civilized  man. 

Other  qualities  contributed  greatly  to  making  gold  and 
silver  the  money  metals.  They  are  singularly  free  from  lia- 
bility to  deterioration.  Rust  does  not  affect  them.  They 
retain  their  luster  with  unusual  constancy.  Most  important  of 
all,  they  have  proved  to  be  sufficiently  abundant  for  money 
use,  and  yet  not  so  abundant  that  they  have  ceased  to  be 
prized.  Any  metal  that  is  fairly  scarce  might  be  selected  for 
monetary  use.  Iron  was  used  in  the  early  days  of  Rome. 
Copper  was  used  to  a  considerable  extent  in  later  times ;  and 
it  is  still  in  use,  though  only  under  conditions  that  deprive  it  of 
much  significance.  In  the  course  of  time,  both  iron  and  copper 
have  been  discovered  and  produced  in  such  great  quantities 

1 1  use  "specie"  to  signify  gold  and  silver  used  for  monetary  purposes, 
whether  coined  or  uncoined. 


THE  PRECIOUS  METALS.    COINAGE  229 

that  they  have  ceased  to  have  any  special  value  from  their 
rarity.  Gold  and  silver  remain  comparatively  scarce.  Though 
common,  and  very  widely  distributed  (gold  perhaps  most  widely 
distributed  of  all),  they  are  rarely  found,  in  large  amounts,  or 
under  conditions  which  enable  great  quantities  to  be  secured  at 
small  cost.  Highly  productive  mines  have  been  not  infre- 
quently discovered,  and  during  our  own  time  new  sources  are 
being  exploited  to  a  striking  extent.  Some  of  these  changes 
have  had  far-reaching  effects  on  prices  and  on  the  modes  of 
use  for  the  two  metals.  Some  of  them,  too,  have  caused  the 
question  to  be  raised,  at  one  time  and  another,  whether  silver, 
or  gold,  or  both,  might  not  become  so  abundant  and  so  cheap 
as  no  longer  to  be  fit  to  serve  as  money.  On  the  whole,  how- 
ever, their  scarcity  and  high  cost  have  continued.  Though  now 
produced  in  quantities  that  are  enormous  as  compared  with 
those  of  former  centuries,  their  annual  production  is  still  very 
small  as  compared  with  that  of  iron,  lead,  copper,  tin,  and  zinc.1 
The  continued  use  of  gold  and  silver  for  money  rests  very 
largely  on  convention,  not  on  the  intrinsic  factors  of  beauty 
and  scarcity.  Once  established  as  the  money  metals,  they 
retain  their  position  to  a  great  degree  by  force  of  custom. 
Anything  which  passes  readily  from  hand  to  hand  has  value 
from  its  mere  acceptability.  The  strong  influence  of  conven- 
tion and  habit  is  illustrated  by  the  wampum  of  the  American 
Indians.  These  strings  of  shells,  originally  sought  because 
fancied  for  ornament,  were  in  course  of  time  accepted,  without 
thought  of  their  ornamental  qualities,  as  a  medium  of  exchange 

1  The  total  production,  the  world  over,  of  the  more  familiar  metals  was  in 
1900:  — 

Metric  Tons 

Pig  Iron 41,000,000 

Lead 860,000 

Copper 486,000 

Zinc 471,000 

Tin 85,000 

Aluminum 7,800 

Nickel 7,500 

Silver 5,650 

Gold .  .  388 


230   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

for  the  Indian  tribes  and  the  early  settlers.  Among  certain 
African  tribes,  tiny  axes  (called  bikei)  serve  as  the  medium  of 
exchange.  It  is  clear  that  they  are  conventionalized  survivals 
from  a  time  when  the  purpose  was  served  by  real  axes,  which 
had  the  prime  quality  of  general  acceptability.1  Paper  money 
illustrates  the  same  tendency.  In  the  first  stages  of  its  use,  it 
had  to  be  really  exchangeable  on  demand  for  specie ;  otherwise 
it  would  not  be  taken  in  payment.  But  once  people  were 
used  to  it,  and  accustomed  to  seeing  it  received  by  every  one 
and  paid  out  by  every  one,  it  proved  able  to  circulate  as  money 
with  little  reference  to  its  convertibility  into  specie.2  Specie 
has  had  for  many  centuries  the  established  position  which 
paper  money  has  secured  within  very  modern  times.  Just 
because  all  the  world  accepts  it  as  money,  it  is  peculiarly  fit  to 
serve  as  money. 

Further,  the  fact  that  specie  serves  so  universally  as  money 
tends  to  maintain  its  value,  by  giving  it  a  utility  for  social 
prestige.  Many  of  the  non-monetary  purposes  for  which  gold 
and  silver  are  used  have  become  of  minor  importance.  Brass 
and  sundry  imitations  often  do  as  well.  Between  the  service- 
ability of  plated  ware  and  solid  silver  there  is  no  substantial 
difference.  The  one  great  utility  which  the  sterling  metal 
retains  is  like  that  of  the  diamond,  —  it  satisfies  the  love  of 
distinction.  The  fact  that  gold  and  silver  are  used  as  money 
keeps  up  their  value;  the  fact  that  they  are  valuable  gives 
them  utility  for  display;  and  this  in  turn  serves  to  sustain 
their  value  for  monetary  as  well  as  for  non-monetary  uses. 

§  3.  Coins  are  stamped  and  certified  pieces  of  metal.  Uni- 
formity, and  consequent  ease  in  reckoning  prices,  are  made 
possible  by  coinage.  The  fact  that  the  metals  can  be  split  up 
into  pieces  absolutely  uniform  is  one  of  the  qualities  which  fit 
them  for  monetary  use ;  though,  to  be  sure,  it  is  a  quality  pos- 
sessed not  only  by  gold  and  silver,  copper  and  nickel,  but  by 
other  metals  as  well. 

1  See  Miss  Mary  Kingsley's  Travels  in  West  Africa,  p.  320. 

2  See  below,  Chapter  23,  §  1. 


THE  PRECIOUS   METALS.    COINAGE  231 

Coinage  has  been  almost  universally  carried  on  as  a  public 
function.  In  all  advanced  countries  it  is  now  so  carried  on 
without  exception.  Conceivably,  private  persons  might  under- 
take it,  the  users  of  money  being  allowed  to  judge  of  the  weight 
and  fineness  of  the  pieces  as  they  are  allowed  to  judge  of  the 
quality  of  the  spoons  and  forks  which  they  use.  In  this  way 
silver  is  used  to  the  present  day  as  the  medium  of  exchange  in 
China.  But  the  convenience  of  coins  as  a  medium  of  exchange 
would  be  immensely  lessened  if  every  one  had  to  ascertain  for 
himself  whether  each  piece  was  what  it  purported  to  be.  Gov- 
ernments therefore  reserve  to  themselves  the  monopoly  of 
coinage,  and  punish  as  a  crime  the  manufacture  by  private 
persons  of  money  pieces.  Historically,  a  strong  reason  for  the 
public  monopoly  of  coinage  was  the  desire  of  kings  and  princes 
to  make  a  profit  by  coinage  operations,  often  dishonestly, 
through  intentional  debasement  of  the  coin.1  In  modern 
times,  however,  the  monopoly  is  maintained  because  through 
it  alone  uniformity  in  the  circulating  medium  can  be  secured. 

Coins  are  so  manufactured  that  they  cannot  be  clipped  or 
whittled  without  easy  detection  of  the  defect.  Hence  designs 
are  always  put  on  both  sides,  and  the  edges  have  corrugations 
(milling)  or  lettering.  If  the  coins  were  simply  round  flat  pieces 
of  metal  with  smooth  edges,  shavings  could  be  scraped  or  cut 
from  them  without  easy  detection.  Such  "sweating"  was 
common  in  earlier  days,  before  the  art  of  coinage  had  been 
perfected.  Modern  machinery  turns  out  pieces  so  skillfully 
manufactured  that  troubles  of  this  sort  have  practically  ceased. 

Coins,  again,  are  never  made  of  pure  metal  Gold  and  silver, 
without  alloy,  are  soft,  and  coins  made  of  them  alone  would 
wear  out  fast  under  active  use.  Hence  a  small  percentage  of 
base  metal  —  usually  copper  —  is  added,  the  mixture  giving 
the  needed  hardness  and  toughness.  In  most  countries,  gold 
and  silver  coins  are  900  fine;  that  is,  they  contain  900  parts 
in  gold  or  silver  for  every  1000  of  gross  weight.  This  is  the 

1  For  a  modern  instance  of  the  same  sort,  see  Slatin's  Fire  and  Sword  in  the 
Sudan,  pp.  541-643. 


232  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

fineness  of  the  coins  of  the  United  States.  Great  Britain  still 
coins  her  gold  pieces  with  a  fineness  of  916| ;  that  is,  the  pro- 
portion of  alloy  is  not  1  in  10,  but  1  in  12. 

In  the  typical  case,  which  alone  we  consider  for  the  present, 
there  is  free  coinage.  That  is,  every  holder  of  bullion  may 
bring  it  to  the  mint,  and,  no  matter  how  much  he  brings,  have 
it  converted  into  coin.  The  cost  of  manufacturing  the  coin  is 
usually  borne  in  modern  communities  by  the  public.  When 
so  borne,  coinage  is  gratuitous  as  well  as  free.  But  the  mint 
may  return  to  the  applicant  coins  containing  a  slightly  less 
amount  of  specie  than  he  presented.  The  difference  retained 
by  the  mint  then  constitutes  a  charge  to  meet  its  expenses, 
in  whole  or  in  part.  Such  a  difference  or  deduction  is  called  a 
seigniorage  (a  name  derived  from  the  exclusive  coinage  rights 
of  the  king  or  feudal  seigneur).  Where  a  seigniorage  is  charged, 
the  exchange  value  of  coin  may  exceed  to  that  extent  the  value 
of  bullion.  The  mints  of  most  countries,  however,  return  to 
the  person  who  presents  gold  bullion  precisely  the  same  weight 
of  fine  gold  in  the  shape  of  coins.  Sometimes,  indeed,  this 
return  is  not  immediate ;  there  is  a  delay  corresponding  to  the 
length  of  time  required  for  the  manufacture  of  the  coin.  Thus, 
in  the  United  States,  a  period  of  six  weeks  usually  elapses 
between  the  delivery  of  bullion  and  the  return  of  coin.  Such 
a  delay  may  cause  the  value  of  bullion  to  be  slightly  less  than 
the  value  of  coin,  even  though  there  be  free  coinage  without  seign- 
iorage, since  there  is  a  loss  of  interest  during  the  period  of 
waiting.  These  causes  of  divergence  between  gold  bullion 
and  gold  coin  —  whether  seigniorage  or  delay  in  coinage  — 
have  ceased  to  be  of  appreciable  importance. 

Not  only  can  gold  bullion  be  converted  into  coin  at  the 
mint  without  charge,  or  for  a  trifling  charge,  but  gold  coin 
can  be  readily  converted  into  gold  bullion,  either  by  private 
melting,  or  by  arrangement,  common  at  the  mints,  for  giving 
bullion  in  exchange  for  coin  at  fixed  rates.  The  situation  is 
very  different  with  silver,  copper,  and  nickel,  which  are  not 
freely  coined,  and  which  present  problems  of  their  own.  As 


THE  PRECIOUS  METALS.     COINAGE  233 

for  gold,  it  may  be  said,  without  substantial  variance  from  the 
facts,  that  bullion  and  coin  are  interchangeable. 

The  rate  at  which  coin  is  given  for  bullion  is  the  "mint 
price  of  gold."  In  England  the  mint  price  of  standard  gold  is 
£3  17s.  10%d.  per  ounce;  each  ounce  is  manufactured  into 
sovereigns  at  this  rate.  In  France  the  mint  price  of  fine  gold 
is  3447.74  francs  per  kilogram,  in  Germany  it  is  2790  marks  per 
kilogram;  the  figures  again  indicating  how  many  francs  or 
marks  are  manufactured  from  the  kilogram  of  gold.  Because 
the  amount  of  gold  coin  given  for  bullion  never  varies  (so  long 
as  the  coinage  legislation  remains  unchanged),  people  often 
speak  of  the  value  of  gold  as  unvarying.  Accustomed  to  think 
of  all  exchanges  and  all  values  in  terms  of  price,  they  think  of 
the  value  of  gold  as  the  price  (the  mint  price)  of  gold  bullion. 
But  obviously  the  value  both  of  gold  bullion  and  of  gold  coin 
is  really  a  very  different  matter.  It  depends  on  the  general 
range  of  prices  of  commodities,  or,  rather  it  is  the  general 
range  of  prices ;  and  this  is  by  no  means  free  from  variation. 

In  the  United  States,  the  phrase  "mint  price  of  gold"  is  not 
often  used,  because  our  coinage  legislation  proceeds  not  by 
specifying  what  number  of  dollars  shall  be  manufactured  out 
of  a  given  weight  (say  an  ounce)  of  gold,  but  by  specifying 
how  much  gold  the  dollar  shall  contain.  The  dollar  is  required 
to  contain  23.22  grains  of  fine  gold.  Dollar-pieces  are  no  longer 
corned ;  they  proved  too  small  for  convenient  use ;  five-dollar 
pieces  are  coined  with  five  times  this  weight  of  gold,  ten-dollar 
pieces  with  ten  times  the  weight.  The  mint  price  of  gold,  if 
that  phrase  were  used  with  reference  to  OUT  coinage  system, 
would  be  $20.67  per  ounce. 

§  4.  Before  closing  this  introductory  chapter,  something 
may  be  said  of  the  place  which  money  and  the  mechanism  of 
exchange  hold  among  the  factors  that  bear  on  the  prosperity 
of  a  community. 

Every  person  sells  his  wares  or  services  for  money,  and 
commands  the  wares  and  services  of  others  in  proportion  as  he 
has  more  or  less  money.  It  is  natural  to  suppose  that  what 


brings  prosperity  to  the  individual  brings  prosperity  to  all. 
Yet  a  moment's  reflection  makes  it  clear  that  here,  as  so  often, 
the  inference  is  not  warranted.  If  all  persons  sell  their  wares 
for  more  money,  no  one  gains  thereby.  The  individual  gains 
from  having  more  money  only  if  others  have  not  more  money, 
—  if  he  can  buy  from  others  at  as  low  prices  as  before.  If 
all  prices  and  all  money  incomes  are  high,  no  one  is  bettered 
thereby.  Money  is  the  means  by  which  each  person  procures 
the  comforts  and  necessaries  of  life;  or,  to  speak  more  accu- 
rately, it  is  the  medium  by  which  each  person  exchanges  the 
particular  things  he  produces  or  owns  for  the  various  commodi- 
ties which  he  wishes  to  buy.  The  more  money  there  is,  the 
more  of  this  medium  is  used  in  every  act  of  exchange.  But 
prosperity  depends  on  the  abundance  of  the  things  exchanged, 
not  on  that  of  the  counters  used  in  effecting  the  exchanges. 

This  is  so  obvious  that  mere  statement  suffices  for  proof. 
None  the  less,  it  happens  often  that  people  who  are  half  trained, 
and  see  only  one  aspect  of  economic  phenomena,  believe  that 
abundance  of  gold  or  silver,  or  of  paper  substitutes  for  them, 
is  the  one  thing  needful  to  make  the  world  better  off.  Many 
educated  and  intelligent  persons,  who  would  scorn  to  hold  this 
opinion  in  its  crudest  form,  yet  hold  some  phase  of  it  by  impli- 
cation. Thus,  in  connection  with  trade  between  one  country 
and  another,  most  people  assume  that  such  a  state  of  foreign 
trade  as  brings  money  into  the  country  leads  to  prosperity, 
while  such  a  state  as  carries  money  out  leads  to  adversity. 
All  notions  of  this  sort  are  the  results  of  half  thinking.  The 
flow  of  specie  into  a  country  or  out  of  it,  in  the  course  of  inter- 
national trade,  is  usually  a  matter  of  indifference.  Where  it 
is  a  matter  of  consequence,  the  mere  increase  or  decrease  in 
the  supply  of  money  is  only  the  first  step  in  a  series  of  events 
that  may  affect  the  country's  prosperity.1  Whenever  a  person 
speaks  of  that  which  "brings  money  into  the  country"  (or 
into  the  city  or  the  village)  as  being  good  for  it,  the  probabilities 

1  See  the  discussion  of  international  trade  in  Book  IV,  especially  Chapter  32, 
and  Chapter  36,  §  1. 


THE  PRECIOUS  METALS.    COINAGE  235 

are  that  he  has  not  mastered  the  elementary  principles  of 
economics.  One  of  the  simplest  of  these  principles  is  that 
money  is  primarily  an  instrument  for  enabling  the  division  of 
labor  to  work  out  its  end  with  smoothness,  and  that,  bar- 
ring some  niceties  presently  to  be  considered,  its  large  or 
small  supply  is  a  matter  of  no  consequence. 

But  though  the  quantity  of  money,  and  the  consequent  use  of 
more  or  less  of  the  counters  in  each  operation  of  exchange,  be 
matters  of  indifference,  the  universal  use  of  money  in  exchanges 
is  by  no  means  a  matter  of  indifference.  It  has  not  merely 
the  obvious  effect  of  facilitating  the  division  of  labor  and  so  pro- 
moting the  output  from  the  operations  of  production:  it  has 
ulterior  consequences  no  less  important.  Without  it  neither 
merchants  and  traders  nor  manufacturers  could  carry  on  large- 
scale  operations.  All  the  phases  of  large-scale  production,  with 
its  far-reaching  social  consequences,  are  dependent  on  a  de- 
veloped and  smooth-working  money  regime ;  it  is  indissolubly 
connected  with  capitalism  and  capitalistic  enterprise.  It  un- 
derlies all  lending  and  borrowing,  all  investment,  the  issue  of  cor- 
porate securities,  financial  operations  of  every  kind.  It  has 
psychological  effects  as  well  as  effects  obviously  economic.  It 
affords  a  universal  goal  for  the  instinct  of  accumulation  and 
possession,  creating  an  environment  in  which  every  one  strives 
for  money,  half  forgetful  of  the  purposes  which  the  possession 
of  money  serves.  All  things  are  put  in  a  pecuniary  light,  all 
effort  is  proximately  to  make  money,  all  efficiency  and  all  prod- 
uct are  measured  in  terms  of  money.  Though  not  the  funda- 
mental cause  underlying  the  problems  of  the  unequal  division  of 
wealth  and  income,  it  is  yet  a  condition  of  the  emergence  of 
these  problems  in  the  characteristic  modern  forms :  social  classes 
distinguished  by  differences  in  money  means,  capital  owned 
by  comparatively  few.  From  one  point  of  view  the  least 
essential  part  of  the  organization  of  production  and  distri- 
bution, it  is  from  another  point  of  view  the  one  essential  part. 
Without  it,  the  characteristic  modern  problems  could  hardly  be 
imagined. 


CHAPTER  18 
THE  QUANTITY  or  MONEY  AND  PRICES 

§  1.  What  determines  the  value  of  money?  That  is,  what 
determines  the  general  range  of  prices?  The  value  of  money 
obviously  is  high  when  the  general  range  of  prices  is  low ;  for 
a  given  amount  of  money  will  then  buy  much  of  other  things. 
Its  value  obviously  is  low  when  the  general  range  of  prices  is 
high ;  for  a  given  amount  of  money  will  then  buy  little  of  other 
things.  What,  now,  causes  its  value  to  be  high  or  low,  prices 
to  be  low  or  high  ? 

The  first  step  toward  answering  this  question  is  to  understand 
the  relation  between  the  quantity  of  money  and  its  value.  The 
fundamental  relation  is  a  very  simple  one.  Double  the  quantity 
of  money,  and,  other  things  being  equal,  prices  will  be  twice  as 
high  as  before  and  the  value  of  money  one  half.  Halve  the 
quantity  of  money,  and,  other  things  being  equal,  prices  will 
be  one  half  what  they  were  before,  and  the  value  of  money 
double.  That  an  increase  in  quantity  tends  to  lower  value,  is  a 
proposition  holding  good  of  all  commodities.  The  special  prop- 
osition concerning  money  is  that  its  value  tends  to  vary  pre- 
cisely in  proportion  to  its  quantity.  This  constant  relation  does 
not  hold  good  of  any  other  commodity.  Double  the  quantity  of 
wheat,  and  its  value  will  probably  fall  to  much  less  than  half 
of  what  it  was  before.  Double  the  quantity  of  sugar,  and  its 
value  will  probably  fall  by  no  means  to  one  half.  For  both 
wheat  and  sugar,  the  outcome  will  depend  on  the  elasticity 
of  demand.  But  in  the  case  of  money,  there  is  no  question  as 
to  elasticity  of  demand,  and  no  such  difficulty  in  prediction.  The 
value  of  money,  under  the  simplest  conditions,  is  exactly  inverse 
to  its  quantity. 

236 


THE  QUANTITY  OF  MONEY  AND  PRICES        237 

This  is  what  is  called  the  quantity  theory  of  money.  Con- 
cerning it  a  hot  controversy  has  long  waged.  It  has  been  ve- 
hemently denied;  and  often  it  has  been  erroneously  stated. 
Rightly  stated  it  conforms  to  the  facts,  but  it  must  be  rightly 
stated  and  understood.  In  the  preceding  paragraph  it  has 
been  put  boldly,  with  the  purpose  to  bring  out  clearly  the 
fundamental  truth.  But  the  reader  will  note  the  phrases 
"other  things  being  equal"  and  "under  the  simplest  conditions." 
Great  qualification  and  elaboration  will  be  required  before  the 
bold  statement  can  be  made  to  fit  the  complicated  phenomena 
of  actual  life,  especially  in  modern  times.  The  last  word  cannot 
be  said  until  a  long  series  of  topics  have  been  covered.1  For  the 
present,  let  us  consider  the  essential  ground  on  which  the  prop- 
osition rests,  and  some  of  the  simplest  qualifications. 

These  essential  grounds  are  found  in  the  nature  of  the  demand 
for  money.  People  often  say  that  the  demand  for  money  is 
without  limit.  They  mean  thereby  that  any  individual  desires 
to  secure  possession  or  control  of  as  much  as  he  can.  But  he 
desires  possession  or  control  as  a  means,  not  as  an  end.  Money 
is  not  eaten  or  drunk  or  directly  enjoyed.  It  is  a  means  of  get- 
ting other  commodities ;  it  is  sought  in  order  to  be  spent.  We 
may  set  aside,  as  negligible,  the  case  of  the  miser  who  gloats 
over  money  for  its  own  sake,  and  also  some  other  possible  cases 
of  hoarding.  All  the  money,  whether  any  individual  has  con- 
trol of  much  or  little  of  it,  is  spent  sooner  or  later.  The  demand 
for  it  —  what  is  offered  in  exchange  for  it  —  consists  of  the 
commodities  on  sale.  But  the  commodities  on  sale  are  simply 
all  the  commodities  that  are  to  be  exchanged.  The  demand  for 
money,  in  any  given  community  at  any  given  time,  is  constant. 
It  h  not  subject  to  change  because  of  the  greater  or  less  range  of 
prices.  Whether  goods  sell  for  less  or  more,  all  of  them  will 
still  be  sold,  and  will  still  be  offered  for  money.  Hence,  when 
there  is  twice  as  much  money,  the  same  number  of  commodities 
will  be  offered  for  the  money,  and  prices  will  be  twice  as  high  as 
before. 

1  See  Chapter  31,  at  the  close  of  this  Book. 


238   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

In  other  words,  there  is  no  such  thing  as  elasticity  in  the  de- 
mand for  money.  The  principle  of  marginal  utility  is  not  appli- 
cable. When  wheat  and  sugar  are  offered  more  abundantly  in 
the  market,  their  value  falls  according  to  the  decreasing  utility 
of  successive  increments.  The  total  sum  spent  on  any  one  com- 
modity —  the  quantity  sold  multiplied  by  the  price  per  unit  — 
may  become  greater  or  less  as  the  number  of  units  grows  larger. 
But  the  total  amount  of  goods  offered  for  money,  which  con- 
stitutes the  demand  for  money,  is  not  affected  by  its  value. 
That  total  remains  always  the  whole  number  of  commodities 
that  are  exchanged  through  this  medium.  The  general  process 
is  the  exchange  of  the  whole  number  of  commodities  for  the  whole 
number  of  money  pieces ;  the  equation  fixes  the  value  of  money 
according  to  the  relative  abundance  of  money  and  of  goods. 

§  2.  Let  us  now  begin  to  introduce  the  explanations  and  quali- 
fications of  this  fundamental  principle.  In  the  first  place,  we 
should  not  speak  of  the  whole  number  of  commodities,  or  even  of 
the  whole  number  exchanged ;  but  only  of  the  number  exchanged 
through  the  medium  of  money.  Some  goods  are  consumed  by 
those  who  produce  them,  and  do  not  enter  the  circle  of  exchange 
at  all.  Such  are  agricultural  products  consumed  by  those  who 
grow  them.  These  evidently  do  not  constitute  at  any  time 
demand  for  money.  But  with  the  growing  elaboration  of  the 
division  of  labor,  the  proportion  of  goods  so  used  tends  to  be- 
come steadily  less.  In  a  country  like  the  United  States  at  the 
present  time  it  is  not  far  from  the  truth  to  say  that  air  things 
that  are  produced  are  exchanged. 

Nor  is  it  far  from  the  truth  to  say  that  all  things  exchanged  at 
all  are  sold  for  money  and  exchanged  through  money.  So  far 
as  barter  is  practised,  there  is  obviously  no  demand  for  money. 
Goods  exchanged  by  barter  constitute  demand  directly  for  each 
other.  But  barter  has  disappeared  even  more  completely  than 
production  for  one's  own  consumption. 

Much  more  important  is  a  qualification  as  to  the  rate  or  man- 
ner in  which  goods  and  money  meet  each  other  in  exchange. 
The  preceding  statements  seem  to  imply  that  all  the  goods  are 


THE  QUANTITY  OF  MONEY  AND  PRICES       239 

exchanged  for  all  the  money  in  one  transaction.  Obviously  this 
does  not  happen.  At  any  given  moment,  or  on  any  given  day, 
only  a  fraction  of  the  goods  is  being  sold,  and  only  a  fraction  of 
the  money  is  being  used  in  purchases.  Here,  as  elsewhere  in 
economics,  we  should  have  in  mind  a  flow  rather  than  a  fund. 
The  total  stock  of  commodities  is  indeed  sold  sooner  or  later,  and 
may  be  conceived  as  a  fund.  But  only  a  portion  of  it  actually 
comes  to  the  monetary  market  in  any  one  day  or  week  or  other 
unit  of  time,  the  rest  following  in  orderly  sequence.  There  is  a 
flow  of  goods  into  actual  exchange.  Similarly,  the  total  quan- 
tity of  money  does  not  constitute  a  fund,  but  flows  into  actual 
use  for  purchasing  goods  in  a  tolerably  regular  sequence. 

The  phrase  "rapidity  of  circulation"  has  been  used  for  money, 
to  indicate  this  obvious  fact.  Of  the  total  money  actually  on 
hand  in  a  community  a  portion  only  is  at  any  given  time  at  work, 
so  to  speak.  The  money  idle  in  our  pockets  does  not  directly 
affect  prices;  only  that  which  is  buying  goods  at  the  counter 
does  so.  What  proportion  is  at  work,  depends  on  the  habits  of 
the  people.  It  is  affected  by  their  geographical  distribution 
and  by  the  character  of  their  industries.  In  a  thinly  settled 
agricultural  section,  where  access  to  shops  is  not  easy  or  frequent, 
a  larger  portion  of  the  money  is  likely  to  be  idle  than  in  a  thickly 
settled  manufacturing  or  commercial  section.  The  temper  of 
the  people  is  a  factor.  If  they  are  confident  of  themselves, — 
perhaps  unduly  confident,  and  thoughtless  of  the  morrow, — 
they  are  likely  to  spend  money  as  fast  as  it  comes  into  their 
hands,  and  let  little  of  it  remain  idle  at  any  time. 

These  remarks  apply  to  the  larger  transactions  of  merchants 
and  dealers  as  well  as  to  the  everyday  purchases  of  consumers. 
Traders  and  producers  always  have  on  hand  more  money  than 
they  are  using  in  purchases ;  the  proportion  depending  partly  on 
the  nature  of  their  business  operations,  partly  on  their  tempera- 
ment. The  fact  that  these  classes,  in  countries  like  the  United 
States,  use  not  actual  cash,  but  checks  against  bank  deposits, 
does  not  alter  the  situation;  it  only  supplies  another  illustra- 
tion of  the  difference  between  the  fund  of  money  and  its  flow. 


240   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

The  total  of  their  deposits  in  banks  constitutes  the  fund;  the 
checks  by  which  purchases  are  effected  from  day  to  day  con- 
stitute the  flow.  Though  we  are  anticipating  in  speaking  of 
deposits  and  checks,  whose  use  as  substitutes  for  cash  will  be 
considered  in  due  time,1  it  may  be  noted  that  the  same  principles 
are  applicable  to  this  more  complex  monetary  medium  as  to 
money  in  its  simplest  form.  In  every  form,  the  medium  of  ex- 
change has  its  flow,  or  rate  of  use,  —  its  rapidity  of  circulation. 

Similarly,  goods  have  their  rapidity  of  circulation.  In  more 
familiar  language,  they  have  their  rate  of  turnover.  This  also 
depends  obviously  on  a  great  variety  of  circumstances.  It  is 
likely  to  be  rapid  in  a  large  city,  slower  in  the  country.  It  is 
affected,  like  the  flow  of  money,  by  the  temper  of  the  people.  It 
is  likely  to  be  quicker  in  an  energetic  and  restless  country  like 
the  United  States  than  in  a  more  slowly  moving  country  like 
France.  It  is  likely  to  vary  in  different  parts  of  the  United 
States.  It  varies,  too,  in  different  branches  of  trade.  The 
turnover  of  a  grocer's  shop  is  more  rapid  than  that  of  a  hardware 
dealer's,  that  of  a  flour  mill  than  that  of  a  textile  factory.  Yet  the 
flow  of  goods  as  a  whole  takes  place  steadily  and  continuously, 
and  in  a  given  community  with  a  surprisingly  regular  course. 

Thus  the  proportion  of  money  which  is  actually  buying  goods 
is  not  accidental ;  it  is  determined  by  the  silent  force  of  custom. 
It  may  be  irregular  for  an  individual,  but  over  thousands  and 
millions  of  individuals  it  follows  a  steady  course.  The  flow  of 
goods  to  market  takes  place  at  a  similarly  regular  rate.  Hence 
we  may  argue  with  confidence  that  if  "the  total  quantity  of  money 
be  increased,  that  quantity  which  is  used  in  making  purchases 
at  any  given  time  will  be  correspondingly  increased. 

Suppose,  for  example, — to  use  an  illustration  of  Mill's, — 
that  suddenly  every  one  in  the  community  has  twice  as  much 
money.  The  only  thing  that  can  be  done  with  it  is  to  spend  it. 
There  is  nothing  to  alter  the  habits  of  the  people  ;  nothing  to 
cause  a  larger  proportion  to  be  kept  in  the  pocket  or  in  reserve.2 

1  See  below  in  this  Book,  Chapter  24,  §  3. 
1  See,  however,  what  is  said  below,  in  §  5. 


THE  QUANTITY  OF  MONEY  AND  PRICES        241 

The  quantity  of  goods  remains  the  same,  nor  is  there  anything  to 
alter  the  mode  hi  which  people  and  dealers  bring  their  goods  to 
market.  The  flow  of  money  will  be  doubled,  the  flow  of  gooda 
unchanged,  and  prices  will  be  twice  as  high  as  before. 

The  same  effect  which  would  ensue  from  a  doubling  in  the 
quantity  of  money  would  ensue  also  from  a  doubling  of  its  rapid- 
ity of  circulation.  If  twice  as  much  of  the  total  stock  is  steadily 
in  use  for  purchasing  goods,  the  effect  is  the  same  as  if  the  quan- 
tity were  doubled  without  any  change  in  the  ways  of  using  it. 

The  propositions  which  were  laid  down  in  the  opening  para- 
graph obviously  assumed  that  the  quantity  of  goods,  and  the 
flow  of  goods  into  exchange,  remain  constant.  So  much  was 
implied  by  the  qualification  "other  things  remaining  the  same." 
Needless  to  say,  the  quantity  of  goods  does  not  always  remain 
the  same.  If  it  be  doubled  when  the  quantity  of  money  is 
doubled,  prices  will  be  unchanged.  If  goods  be  doubled,  money 
being  the  same,  and  the  flow  of  goods  to  market  unaffected, 
prices  will  fall  one  half.  If  the  flow  of  goods  to  market  —  their 
rapidity  of  circulation  —  be  so  affected  that  twice  as  large  a 
proportion  of  goods  are  regularly  offered,  prices  will  again  fall 
one  half. 

Rapidity  of  circulation  is  greater  for  money  than  for  goods. 
To  put  it  in  other  words,  the  proportion  which,  at  any  one  time, 
the  money  actually  offered  for  goods  bears  to  the  total  supply 
of  money  is  greater  than  the  proportion  which  the  goods  offered 
for  money  bear  to  the  total  supply  of  goods  awaiting  exchange. 
The  reason  for  this  difference  is  obvious.  Money  can  always  be 
used  without  delay  in  purchases ;  goods  can  often  be  sold  but 
slowly.  Money  need  never  wait  for  a  buyer ;  goods  must  often 
wait  for  one.  Many  commodities  have  necessarily  a  slow  turn- 
over, as  hardware  and  household  furniture.  Other  things,  like 
dwellings  to  let,  warehouses,  and  factories,  are  in  the  market 
only  by  fractions  or  installments,  —  only  the  utilities  which  they 
shed,  so  to  speak,  are  being  offered  for  sale, — and  their  disposal 
is  sluggish.  Money  comes  into  the  market  quickly.  Though 
there  may  be  hoards,  and  occasionally  an  accumulation  of  unused 


242       MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

money  in  the  hands  of  people  who  are  getting  larger  incomes 
than  they  are  used  to,  money  in  the  main  is  kept  at  work 
briskly,  at  a  rate  greater  or  less  for  any  given  time  and  country 
according  to  the  ways  and  customs  of  the  people. 

These  various  corrections  and  qualifications  of  the  simple 
fundamental  principle  the  reader  will  hereafter  be  supposed  to 
bear  in  mind.  We  shall  speak  of  the  value  of  money  as  deter- 
mined by  its  quantity ;  meaning  thereby  that,  if  other  things  re- 
main the  same,  an  increase  of  the  total  stock  of  money  brings  a 
corresponding  increase  in  the  flow  of  money  used  in  making  per- 
chases  and  adds  pro  tanto  to  the  money  offered  in  exchange  for 
commodities. 

§  3.  Let  us  proceed  now  to  inquire  how  far  the  monetary 
supply  of  specie  is  different  from  its  total  supply. 

The  precious  metals  are  used  in  the  arts  as  well  as  for  mon- 
etary purposes.  But  the  demand  for  them  in  the  arts  fol- 
lows no  such  special  law  as  does  the  demand  for  money.  Utility 
or  satisfaction-yielding  quality  determines  the  demand  for  gold 
trinkets  and  implements  in  the  same  irregular  way  as  it  deter- 
mines the  demand  for  wheat  or  sugar.  The  quantitative  effect 
of  an  increase  of  supply  is  unpredictable;  the  elasticity  of 
demand  may  show  any  scale  of  gradation. 

If  the  same  proportion  of  the  total  supply  of  gold  and  silver 
were  always  used  in  the  arts,  this  difference  between  the  mon- 
etary and  the  industrial  demands  would  be  of  no  consequence 
for  the  theory  of  money.  But  that  proportion  is  not  neces- 
sarily the  same.  To  a  certain  degree  it  is  influenced  by  the 
very  value  of  the  monetary  supply. 

If,  for  example,  prices  and  money  incomes  in  general  should 
go  up,  in  consequence  of  greater  abundance  of  gold,  gold  bullion 
would  not  advance;  since,  as  we  have  seen,  gold  bullion  is 
always  at  the  same  price  in  terms  of  coin.  For  gold  jewelry,  spec- 
tacles, and  the  like,  the  raw  material  would  be  as  cheap  as  before ; 
they  would  advance  in  price  only  so  far  as  the  expense  of  manu- 
facturing them  from  the  bullion  would  be  greater.  Relatively 
to  money  incomes  they  would  be  cheaper  than  before.  This 


THE  QUANTITY  OF  MONEY  AND  PRICES       243 

greater  cheapness  would  almost  certainly  cause  more  to  be 
bought  than  before,  and  a  greater  proportion  of  the  bullion 
would  be  diverted  into  the  arts.  A  scarcity  of  gold,  and  con- 
sequent fall  in  prices  and  incomes,  might  be  expected  to  have 
the  converse  effect.  Gold  articles  would  be  relatively  dearer,  and 
presumably  would  be  bought  in  smaller  quantity  than  before. 
The  industrial  consumption  would  divert  less  gold  from  the  mint. 

Even  without  a  rise  or  fall  in  the  value  of  gold  (i.e.  in  gen- 
eral prices),  changes  in  habits  and  tastes  affect  its  industrial 
consumption.  Gold  jewelry  may  become  more  fashionable, 
gilding  and  gold  leaf  more  in  vogue,  gold  spectacles  may  be 
thought  more  convenient  or  becoming.  A  greater  proportion 
of  the  available  stock  will  then  be  removed  from  the  monetary 
supply. 

Of  these  two  sets  of  causes,  the  first  seems  to  have  less  effect 
than  the  second.  Changes  in  general  prices  rarely  occur  on 
such  a  scale  as  to  bring  about  considerable  results  of  the  sort 
stated.  The  price  of  jewelry  and  other  gold  articles  is  affected 
not  only  by  the  price  of  bullion,  but  by  the  expenses  of  manufac- 
ture. These  expenses  fluctuate  in  correspondence  with  changes 
in  general  prices.  If  all  prices  go  up,  that  of  bullion  will  in- 
deed remain  the  same ;  but  wages  and  other  items  of  outlay  in 
manufacturing  jewelry  will  go  up  as  other  goods  and  services 
do.  An  advance  of  twenty-five  per  cent  in  general  prices  is  a 
very  marked  one.  Yet  such  an  advance  would  mean,  not  that 
gold  articles  would  remain  unchanged  in  price,  but  only  that 
their  prices  would  lag  somewhat  behind  the  general  advance. 
They  would  go  up  perhaps  twenty  per  cent,  instead  of  twenty- 
five.  The  effect  on  their  consumption  would  probably  be 
small. 

The  second  factor  that  bears  on  the  industrial  use  of  the 
metals  —  changes  in  habits  and  fashion  —  seems  to  be  of 
more  importance.  The  great  growth  of  wealth  during  the 
last  half  century  has  led  to  a  larger  use  of  gold  in  the  arts; 
precisely  as  it  has  led  to  a  larger  use  of  diamonds.  Not  until 
recent  years  was  any  methodical  attempt  made  to  ascertain 


244   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

the  extent  and  growth  of  this  use.  For  the  decade  from  1880 
to  1890  the  industrial  consumption  of  gold  (including  export 
to  the  East,  of  which  more  will  be  said  presently)  was  esti- 
mated to  be,  in  terms  of  dollars,  about  $60,000,000  a  year. 
In  1912  the  amount  was  supposed  to  be  triple,  —  about 
$174,000,000  for  that  year.  Some  part  of  this  reported  in- 
crease was  no  doubt  due  to  insufficient  counting  in  the  earlier 
period ;  but  none  the  less,  an  increase  there  undoubtedly  was. 
The  change  was  by  no  means  in  proportion  to  that  in  the  total 
production  of  gold,  which  was  about  $100,000,000  a  year  in 
1880-1890,  and  no  less  than  $460,000,000  in  1912.  In  the 
earlier  period,  more  than  half  of  the  gold  produced  was  diverted 
from  the  monetary  use  of  Western  countries ;  in  the  later  year, 
less  than  two-fifths  was  so  diverted. 

The  total  stock  of  gold  in  the  world  was  estimated  in  1900 
at  about  $9,000,000,000,  of  which  something  more  than  one 
half  was  in  use  as  money,  the  rest  in  use  for  the  arts.  What 
is  in  use  for  the  arts  may  be  regarded  as  practically  lost  from 
the  monetary  supply.  A  part  of  it,  no  doubt,  returns  sooner 
or  later  to  monetary  channels ;  for  plate,  jewelry,  and  the  like 
are  sometimes  melted  and  perhaps  are  then  coined.  But  most 
of  it  is  definitively  lost.  Whatever  part  returns  has  been  little 
influenced  by  the  value  of  money.  Changes  in  fashion  and 
habits  chiefly  determine  the  remelting,  just  as  they  chiefly 
determine  how  much  shall  go  into  the  arts  in  the  first  instance. 
In  the  main,  the  use  of  the  precious  metals  in  the  arts  goes  its 
own  way,  leaving  for  the  monetary  supply  the  annually  accru- 
ing surplus  of  production  over  and  above  the  independent 
industrial  consumption. 

This  separation  of  industrial  from  monetary  use '  is  more 
complete  at  present  than  it  was  in  earlier  times.  In  medieval 
Europe  a  link  might  be  cut  from  a  gold  chain  and  used  in 
making  a  payment ;  and  the  cavaliers  melted  their  plate  freely 
to  supply  funds  for  the  Stuarts.  In  British  India,  where  con- 
ditions continue  in  many  ways  medieval,  the  silver  ornaments 
of  the  natives  and  their  rupees  were  interchanged  constantly 


THE  QUANTITY  OF  MONEY  AND   PRICES        245 

and  freely  until  very  recent  times;  notwithstanding  the  new 
position  of  the  rupee  since  1893,1  they  still  remain  to  a  certain 
degree  interchangeable.  Even  in  advanced  countries  some 
shift  from  monetary  to  industrial  use  takes  place  to  this  day  ; 
but,  as  has  been  said,  there  is  an  increasing  tendency  to  sharp 
demarcation  and  to  the  settlement  of  the  industrial  use  by 
independent  causes. 

The  industrial  consumption  of  silver  has  shown,  like  that 
of  gold,  a  marked  growth  in  recent  times.  In  the  United 
States  it  seems  to  have  more  than  quadrupled  in  the  period 
between  1880  and  1906.2  This  change,  like  the  other,  is  due 
in  large  part  to  increasing  wealth  and  to  a  fashion  for  silver 
plate  and  trinkets.  No  doubt  it  is  due  also  to  the  lower  price 
of  silver.  The  price  of  silver  has  fallen  since  1873  about  one 
half.  But  the  case  of  silver  is  different  in  one  important 
respect  from  that  of  gold.  Silver  is  no  longer  a  freely  coined 
metal ;  it  does  not  become  money  in  the  same  way  as  gold. 
Silver  bullion,  like  tin  or  copper,  has  its  price  in  terms  of  gold, 
and  its  use  in  the  arts  is  affected  by  price  through  the  same 
mechanism  as  tin  and  copper.  The  use  of  gold  is  affected,  as 
we  have  seen,  through  the  more  obscure  and  unfamiliar  in- 
fluence of  ups  and  downs  in  general  prices  and  in  general  money 
incomes. 

§  4.  Still  another  diversion  of  gold  and  silver  from  monetary 
use  is  important  for  the  countries  of  Western  civilization. 
This  is  the  drain  of  specie  to  the  East,  which  has  been  going 
on  for  centuries,  and  seems  likely  to  continue  for  a  long  time 
in  the  future. 

In  the  trade  between  the  West  and  the  East,  and  especially 
that  between  Europe  and  India,  as  far  back  as  we  have  any 
definite  knowledge  about  it,  the  merchandise  sent  from  the 
East  has  exceeded  in  money  value  that  sent  in  return  from 

1  See  below,  Chapter  21,  §  5. 

*  In  the  United  States,  it  seems  to  have  been  less  than  five  million  ounces 
a  year  in  the  early  eighties,  and  over  20  million  ounces  a  year  in  1902-1906. 
See  the  Report  of  the  Director  of  the  Mint  on  the  Production  of  Precious  Metals, 
1906,  p.  27. 


246       MONEY  AND  THE  MECHANISM  OF   EXCHANGE 

the  West.  A  balance  has  remained  steadily  due  to  Eastern 
countries,  and  has  caused  a  steady  flow  of  gold  and  silver,  and 
especially  of  silver,  to  go  to  them  in  payment  of  the  balance. 
The  excess  thus  due  has  sometimes  increased,  sometimes  de- 
clined. It  has  fluctuated  with  the  variations  in  demand  for  the 
several  commodities  exchanged  between  the  two  regions,  with 
the  accidents  of  seasons  and  crops,  with  the  appearance  of 
new  articles  of  export  on  either  side.  On  the  whole,  the  balance 
to  be  paid  by  Western  countries  has  tended  to  become  less  in 
the  last  ten  or  twenty  years,  largely  because  sundry  goods  of 
Western  manufacture  have  been  called  for  in  greater  amount 
by  the  Eastern  population  (petroleum,  for  example,  and  cotton 
cloths).  But  a  balance  to  pay  there  has  been  for  centuries, 
and  still  is.  Hence  specie  steadily  flows  to  the  East. 

This  specie  is  lost  to  the  Western  countries  as  if  it  had  been 
absorbed  once  for  all  in  the  arts,  —  almost  as  if  it  had  been 
dropped  into  the  sea.  It  disappears  from  the  monetary  and 
industrial  supplies  of  Europe  and  America.  India  —  chiefly 
British  India  —  has  been  aptly  described  as  a  sink,  into  which 
flow  gold  and  silver,  and  especially  silver,  never  to  return. 

The  explanation  of  this  complete  diversion  and  almost  disap- 
pearance lies  in  the  unusual  industrial  conditions  of  India ;  con- 
ditions which  are  found  in  other  parts  of  the  East  also,  though 
nowhere  else  so  strikingly.  China  is  in  a  somewhat  similar 
situation,  and  Japan  formerly  was;  but  India,  and  especially 
that  part  which  is  now  British  India,  has  played  much  the 
most  important  role  in  this  curious  monetary  experience.  The 
region  has  long  had  an  enormous  population;  in  1900  some 
three  hundred  millions.  This  population  is  mainly  agricultural  ; 
it  is  ignorant  and  stolid.  It  uses  metallic  money  almost  solely, 
—  very  little  paper  money  or  other  substitutes.  The  rapidity 
of  circulation  of  its  money  is  low.  Moreover,  the  people  are 
given  to  the  use  of  both  gold  and  silver  for  ornament  and  for 
hoarding.  The  bracelets,  rings,  and  jewels  serve  both  to 
gratify  vanity  in  the  present  and  to  store  purchasing  power 
for  possible  want  in  the  future.  Hence  great  amounts  of 


THE  QUANTITY  OF  MONEY  AND  PRICES       247 

specie  can  find  their  way  into  India,  and  flow  into  use,  without 
much  effect  on  general  prices;  indeed,  for  long  periods, 
without  any  measurable  effect  at  all  on  prices.  No  such  steady 
inflow  could  well  take  place  into  a  Western  country  without 
influencing  prices.  As  will  be  seen  when  the  subject  of  inter- 
national trade  is  reached,  a  continued  large  absorption  of  specie 
by  a  highly  organized  industrial  community  is  not  possible. 
A  large  inflow  will  raise  prices ;  this  will  tempt  imports  and 
check  exports;  then  the  flow  of  specie  in  payment  for  excess 
of  exports  will  cease.  But  in  a  country  like  India  the  response 
of  prices  to  increasing  specie  supply  is  very  slow  indeed.  In  the 
course  of  generations,  it  is  true,  a  response  will  be  found.  Dur- 
ing the  last  half  century,  and  especially  the  last  quarter  cen- 
tury, prices  and  money  incomes  in  the  East  have  gone  up, 
not  to  a  marked  degree,  but  appreciably ; 1  but  during  the  pre- 
ceding centuries  the  upward  movement,  though  probably  there, 
had  been  so  slight  and  slow  as  not  to  be  clearly  discernible. 
The  rending  of  old  bonds  of  caste  and  custom,  the  growing 
habituation  to  security  of  property,  the  opening  of  railroads, 
have  much  affected  the  industrial  and  monetary  situation. 
But  it  still  remains  true,  and  will  probably  long  continue  so, 
that  great  quantities  of  the  precious  metals  steadily  flow  to 
the  East,  to  stay  there ;  affecting  prices  and  the  value  of 
money,  it  is  true,  but  so  gradually  that  the  flow  is  rarely  checked, 
and  is  resumed  with  new  force  whenever  a  large  riew  supply  is 
added  to  the  stock  of  Western  nations,  or  whenever  the  demand 
for  Eastern  commodities  causes  an  upward  movement  in  their 
export. 

§  5.  In  one  important  case  an  increase  in  the  supply  of 
money  may  affect  its  mode  of  use,  and  so  introduce  a  new 
factor.  This  is  where  an  added  supply  facilitates  a  transition 
from  barter  to  a  money  regime.  This  sort  of  case  cannot 
occur  when  once  exchange  by  money  is  fully  established,  when 
all  goods  and  services  are  sold  for  money.  Then  an  increase 

1  See  a  paper  by  F.  J.  Atkinson,  on  "  Prices  in  India,  1870-1908,"  in  Journal 
Royal  Statistical  Society,  September,  1909. 


248       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

in  the  quantity  of  money  means  simply  that  two  gold  or  silver 
pieces,  or  five,  or  ten,  are  used  where  one  had  been  used  before. 
Adam  Smith  supposed  this  to  have  been  the  only  important 
consequence  of  the  increase  in  the  European  supply  of  specie 
which  came  in  the  sixteenth  and  seventeenth  centuries  from 
the  American  mines.1  Gold  and  silver  plate  indeed  became 
thereby  more  plentiful,  —  "a  real  conveniency,  though  surely 
a  very  trifling  one."  For  the  rest,  Adam  Smith  goes  on,  "in 
order  to  make  the  same  purchases,  we  must  load  ourselves  with 
a  greater  quantity  of  gold  and  silver,  and  carry  about  a  shilling 
in  our  pocket  when  a  groat  would  have  done  before."  But 
this  was  not  the  only  change  that  took  place.  The  greater 
plenty  of  specie  contributed  to  its  use  in  transactions  pre- 
viously effected  without  it,  and  caused  still  other  transactions 
(exchanges)  to  be  carried  on  which  before  had  not  been  carried 
on  at  all. 

The  period  (about  from  1550  to  1650)  was  one  of  great  in- 
dustrial transformation.  The  economic  regime  of  the  Middle 
Ages  was  being  rapidly  displaced.  Under  that  regime,  the 
division  of  labor  and  exchange  had  been  much  limited,  and  a 
large  proportion  of  the  exchanges  and  payments  that  did  take 
place  were  effected  in  kind,  —  that  is,  by  barter,  not  in  money. 
It  is  conceivable  that  the  break-up  of  such  a  situation,  and  the 
substitution  of  a  complete  monetary  regime,  should  come  about 
without  any  change  in  the  supply  of  money.  This  would  mean 
that  the  same  supply  must  suffice  for  a  larger  number  of  trans- 
actions, and  that  prices  must  go  down.  But  in  communi- 
ties so  tied  by  custom  as  were  those  of  Europe  at  the  time, 
this  process  could  have  taken  place,  if  at  all,  only  with  the 
greatest  difficulty.  The  mere  absence  of  a  supply-  of  specie, 
adequate  for  carrying  on  a  larger  volume  of  transactions  with- 
out a  great  lowering  of  prices,  was  an  almost  insuperable 
obstacle  to  the  extension  of  monetary  exchanges.  The  new 
specie  vastly  facilitated  the  transition.  It  supplied  a  lubrica- 
tor, so  to  speak,  for  the  smooth  and  rapid  working  of  the  more 
1  Compare  what  is  said  of  this  great  change  in  the  next  chapter. 


THE  QUANTITY  OF  MONEY  AND  PRICES       249 

effective  machinery  of  exchange.  It  penetrated  quickly  and 
easily  into  all  western  Europe,  and  made  possible  a  much 
wider  adoption  of  money  payments;  not  only  without  the 
distress,  real  or  fancied,  that  lower  prices  bring,  but,  through 
the  abundance  of  the  supply,  with  markedly  higher  prices. 
Thereby  the  division  of  labor  was  extended  into  many  new 
industrial  fields,  and  the  ease  of  exchange  was  made  greater 
in  many  fields  where  such  a  division  already  was  practised. 
A  real  advance  in  the  efficacy  of  production  was  secured,  and 
a  real  gain  in  welfare.1 

None  the  less,  Adam  Smith's  view,  though  historically  incom- 
plete for  the  particular  case,  was  in  principle  sound.  He  wrote 
at  a  time  when  people  still  had  false  notions  of  the  advantages 
from  the  plentifulness  of  the  precious  metals.  Being  intent 
on  disabusing  them  of  such  notions,  he  was  led  to  overlook  the 
real  advantages  which  a  community  may  secure  from  the  easy 
procurement  of  a  needed  medium  of  exchange.  But  when 
once  this  medium  of  exchange  has  been  procured,  and  when 
once  it  is  in  fully  effective  use,  reasoning  like  Adam  Smith's  is 
not  to  be  gainsaid.  If  ten  times  the  labor  were  given  to  gold 
mining  that  is  now  given,  and  ten  times  the  gold  were  thereby 
got,  the  world  would  not  be  better  off ;  ten  gold  pieces  would 
simply  be  used  in  every  transaction  where  one  is  used  now. 
The  process  of  transition,  to  be  sure,  —  the  change  from  lower 
to  higher  prices,  or  vice  versa,  —  would  bring  some  important 
consequences  of  its  own ;  but  these  would  not  affect  the  final 
outcome.  Barring  the  transitional  effects,  it  is  immaterial 
whether  prices  are  low  or  high,  whether  many  tokens  or  a  few 
are  used  to  facilitate  each  act  of  exchange. 

1  Some  dim  understanding  of  this  fact  —  a  groping  toward  a  substantial  truth 
—  probably  contributed  to  the  over-importance  attached  to  a  plentiful  supply 
of  specie  by  the  writers  of  the  seventeenth  century,  and  commonly  by  those  of 
the  eighteenth  century  also.  But  the  beliefs  of  these  "  mercantile  "  writers  were 
also  much  affected  by  the  political  power  of  those  princes  who,  at  a  time  when 
feudal  dues  were  being  replaced  by  money  taxes  and  payments,  and  when  the 
money  dues  were  yet  hard  to  enforce,  had  the  command  of  plenty  of  specie. 
And  mere  confusion  of  thought  further  explains  their  attitude.  Here,  as  on  so 
many  subjects,  things  which  seem  simple  when  once  they  have  been  cleared  up, 
were  long  puzzling  to  men  of  high  intelligence. 


250   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

It  has  been  suggested  by  some  writers  that  there  is  still 
another  way  in  which  the  play  of  utility  may  affect  the  rela- 
tion between  the  quantity  of  specie  and  its  value;  it  may 
affect  the  monetary  use  directly.  When  money  becomes  more 
abundant,  people,  it  is  said,  will  use  it  less  constantly.  They 
will  keep  more  of  it  in  their  pockets,  use  less  in  purchases. 
The  merchant,  too,  will  keep  in  his  till  a  larger  balance  when 
money  is  plentiful  than  when  it  is  scarce.  But  this,  in  my 
judgment,  is  not  a  probable  result.  There  is  no  good  reason 
to  suppose  that  money  will  be  used  in  a  different  way  when 
there  is  more  of  it.  If,  indeed,  the  increase  in  quantity  takes 
place  under  circumstances  that  destroy  its  general  accep- 
tability (as  in  the  case  of  excessive  paper  money)  the  use  of 
money  and  the  demand  for  it  will  be  affected.1  But  a  mere 
increase  of  specie,  or  of  other  sorts  of  money  enjoying  general 
acceptability,  will  not  affect  its  flow  into  use  or  lessen  the  effec- 
tiveness of  each  unit  in  the  shaping  of  prices.  Any  individual, 
it  is  true,  who  gets  a  larger  share  of  the  total  money  on  hand 
may  thereby  be  led  to  change  his  ways  of  using  it.  A  pros- 
perous person  ordinarily  keeps  a  larger  reserve  of  cash,  in  pro- 
portion to  his  income  and  his  purchases,  than  one  of  slender 
means;  and  the  rapidity  of  circulation  of  the  money  that 
goes  through  his  hands  is  less.  But  if  all  persons  in  the  com- 
munity have  more  money  than  before,  so  that  its  distribution 
among  individuals  and  classes  remains  the  same,  the  mode  of 
using  the  circulating  medium  will  not  be  affected.  The  same 
proportion  will  be  applied  to  purchases  in  any  given  period, 
and  prices  will  go  up  in  proportion  to  the  general  increase  in 
quantity. 

§  6.  In  this  chapter,  be  it  remembered,  the  principles  under- 
lying the  value  of  money  have  been  treated  on  the  assumption 
that  specie  alone  is  used.  This  case  is  obviously  very  different 
from  the  complicated  one  which  we  find  in  the  actual  conditions 
of  civilized  countries,  where  not  only  specie,  but  paper  money 
and  an  intricate  credit  machinery,  are  used  in  effecting  payments. 

1  See  below,  Chapter  23,  §  1. 


THE  QUANTITY  OF  MONEY  AND  PRICES       251 

But  the  same  principles  hold  good  here,  if  adjusted.  In- 
stead of  saying  that  the  general  range  of  prices  depends  (other 
things  being  equal)  on  the  quantity  of  specie,  we  must  say  that  it 
depends  on  the  total  quantity  of  money  means,  or  of  the  avail- 
able total  purchasing  power  in  terms  of  money.  In  proportion 
as  this  total  purchasing  power  becomes  greater  or  less,  prices  will 
rise  or  fall,  —  other  things,  such  as  the  flow  of  commodities  for 
sale  into  the  market,  being  still  assumed  to  be  the  same.  A  very 
troublesome  problem  is  the  relation  between  this  total  of  pur- 
chasing power  on  the  one  hand,  and  the  total  quantity  on  the 
other  hand  of  gold  or  other  freely  coined  specie.  This  problem 
cannot  be  solved  until  the  whole  range  of  substitutes  for  specie 
and  the  whole  machinery  of  credit  payments  have  been  ex- 
amined.1 The  conclusions  of  the  present  chapter  must  there- 
fore be  taken  as  provisional.  Yet  it  may  be  said  at  once  that 
they  do  hold  good  in  the  long  run  of  the  actual  course  of  affairs. 
For  short  periods,  even  for  many  years,  it  is  often  difficult  to 
trace  any  connection  between  the  quantity  of  specie  and  prices. 
Even  in  the  long  run,  it  is  never  possible  to  trace  that  precise 
inverse  relation  to  the  value  of  money  which  has  been  deduced  in 
the  preceding  pages.  On  the  other  hand,  in  the  long  run,  a  rela- 
tion between  the  volume  of  specie  and  prices  is  in  fact  to  be  dis- 
cerned ;  while  the  precise  quantitative  relation  between  prices 
and  the  total  purchasing  power  in  terms  of  money  remains  un- 
shaken. 

1  See  below,  Chapter  31,  where  the  theory  of  prices  is  restated  with  the 
qualifications  amplified. 


CHAPTER  19 
THE  COST  OF  SPECIE  IN  RELATION  TO  ITS  VALUE 

§  1.  The  value  of  money  has  been  considered  in  the  preceding 
chapter  so  far  as  demand  and  supply  directly  affect  it.  But 
the  supply  of  specie,  like  that  of  any  other  article,  is  affected  by 
its  value.  When  value  is  high,  the  supply  is  likely  to  become 
greater ;  when  it  is  low,  supply  is  likely  to  become  less.  Specie 
comes  from  surface  deposits  and  from  mines,  —  chiefly  from 
mines.  What  are  the  conditions  of  supply  ? 

In  general,  articles  yielded  by  mines  show  the  phenomena 
of  varying  costs  and  of  diminishing  returns.  Some  mines  are 
better  than  others ;  any  one  mine  tends,  as  more  is  extracted, 
to  encounter  sooner  or  later  increasing  costs.  On  grounds  of 
general  reasoning,  we  are  then  led  to  expect  that  the  value  of 
the  precious  metals  will  conform  in  the  long  run  to  their  cost 
of  production  at  the  poorest  mine,  or  at  the  poorest  part  of  the 
best  mines.  It  will  conform,  we  should  expect,  to  the  marginal 
cost  of  production. 

In  fact,  however,  no  close  correspondence,  nor  even  a  rough 
correspondence,  can  be  made  out  between  the  cost  of  the  pre- 
cious metals  and  their  value.  This,  at  least,  is  the  situation  with 
regard  to  gold.  For  silver  the  correspondence  is  perhaps  in  very 
recent  times  closer,  yet  through  most  of  human  history  it  has 
been  equally  uncertain  for  silver  and  for  gold.  The  main 
causes  of  this  lack  of  conformity  with  the  theoretical  scheme  are 
three,  —  the  durability  of  the  precious  metals,  the  aleatory  charac- 
ter of  mining,  and  the  irregular  discoveries  of  new  sources  of 
supply. 

Of  these  three  causes,  the  most  important  is  the  first.  The 
durability  of  the  precious  metals  brings  it  about  that  changes  in 
current  output  affect  the  total  stock  very  slowly.  For  most 

252 


THE  COST  OF  SPECIE  253 

commodities  the  supplies  produced  five  years  ago  are  quite  out 
of  the  market.  This  holds  good  even  of  durable  articles  like 
iron  and  copper.  The  iron  mined  five  years  ago  may  indeed  be 
still  in  existence,  but  it  has  been  fashioned  into  implements  and 
is  committed  to  uses  which  practically  withdraw  it  from  the 
market.  So  far  as  gold  and  silver  are  used  in  the  arts,  they  also 
are,  in  the  main,  withdrawn  from  the  market.  But  gold  and 
silver  used  as  money  remain  in  the  monetary  market  indefinitely. 
Even  if  cost  of  production  is  greatly  reduced,  and  the  annual  out- 
put greatly  enlarged,  as  has  been  the  case  in  recent  years,  the 
monetary  stock  changes  but  gradually,  and  value  is  affected  but 
slowly.1 

Next,  the  very  conditions  of  production  at  the  mines  have 
been  irregular  through  almost  the  whole  course  of  history,  and, 
though  perhaps  less  markedly,  remain  irregular  to  this  day.  The 
irregularity  appears  in  mining  not  only  for  gold  and  silver,  but 
for  all  metals.  It  is  difficult  to  ascertain  in  advance  what  will 
come  out  of  a  hole  in  the  ground.  For  those  mineral  products 
which  occur  in  large  masses,  under  conditions  enabling  syste- 
matic tests  and  samples,  the  element  of  uncertainty  and  risk, 
though  ever  present,  is  at  least  greatly  less.  Such  is  the  case 
with  coal  and  iron  ore.  Copper  mining  seems  to  be  much 
more  speculative ;  gold  and  silver  mining,  even  more  so.  With 
these  the  elements  of  uncertainty  are  great,  and  the  obstacles 
in  the  way  of  an  adjustment  of  value  to  marginal  cost  corre- 
spondingly great. 

The  aleatory  character  of  the  production  of  gold  and  silver 
has  been  accentuated  by  another  circumstance.  Mining  for 
them  has  always  had  a  peculiar  fascination,  and  cool-headed  cal- 
culation has  been  absent  more  than  in  other  mining.  In  gen- 


1  The  world's  monetary  stock  of  gold  was  estimated  in  1907  at  roughly 
$7,200,000,000.  (Helfferrich,  Das  Geld,  edition  of  1909,  p.  203.)  The  product 
in  that  year  was  $440,000,000 ;  deducting  the  gold  used  in  the  arts  (130-150 
millions),  there  remained  for  the  year  a  net  addition  to  the  monetary  stock  of 
say  $300,000,000,  or  about  4  per  cent.  As  compared  with  any  period  except  the 
present  decade  (1900-1910),  this  was  ail  extraordinary  addition  to  the  supply, 
absolutely  and  proportionally. 


254   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

eral,  it  might  be  expected  that  there  would  be  successes  enough 
to  offset  (with  some  rough  approximation)  the  failures;  prizes 
against  the  blanks  in  the  lottery.  But,  as  is  so  commonly  the 
case  with  avowed  lotteries,  the  blanks  are  overlooked,  the  prizes 
only  are  seen.  A  gold  mine,  in  everyday  speech,  stands  for  riches. 
Statesmen,  explorers,  investors,  have  been  deceived  by  the 
glamor  of  mining  for  specie.  The  profitableness  of  such  mining 
depends,  not  on  getting  the  specie,  but  on  getting  it  with 
sufficiently  little  labor  and  expense.  A  large  output  may  be  got 
at  an  expense  so  high  as  to  wipe  out  all  profit.  But  people  have 
been  constantly  tempted  to  gold  and  silver  mining  without 
rational  weighing  of  yield  and  cost.  The  late  Professor  Soetbeer, 
a  very  well-informed  and  sagacious  observer,  came  to  the  con- 
clusion that  as  a  whole  the  production  of  the  precious  metals  was 
carried  on  at  a  loss.  Most  persons  who  have  engaged  in  it  have 
overestimated  the  possible  prizes.  They  have  disregarded  not 
only  the  blanks,  but,  to  a  large  extent,  the  inevitable  expenses. 

In  very  modern  times,  gold  and  silver  mining  have  come  to  be 
carried  on  more  systematically,  on  a  larger  scale  and  with  less 
risk.  This  change  is  due  to  the  improvements  in  mining  meth- 
ods which  make  it  possible  to  extract  the  metals  from  low-grade 
ores.  In  former  times,  the  main  sources  of  supply  were  pockets 
of  very  rich  ore,  and  very  rich  alluvial  deposits.  The  occurrence, 
however,  of  such  lucky  finds  is  irregular,  and  their  continued 
productivity,  even  after  they  have  been  hit  upon,  is  even  more 
irregular.  But  there  are  other  deposits,  where  the  ore  has  a 
small  content  of  fine  metal,  but  is  very  large  in  amount  and  is 
easily  tested  and  measured.  By  establishing  a  great  plant,  and 
treating  vast  bodies  of  ore,  quantities  and  profits  can  be  secured 
with  hardly  more  irregularity  than  those  in  mining  iron  ore. 
The  same  is  true  of  alluvial  mining  when  conducted  not  on 
chance  deposits  in  the  beds  of  streams,  but  on  whole  hillsides 
washed  by  powerful  hydraulic  machinery.  Methods  of  this 
more  businesslike  sort  have  brought  the  great  increase  in  the 
output  of  gold  and  silver  during  the  generation  just  passed. 

Third,  and  closely  connected  with  what  has  just  been  said,  is 


THE  COST  OF  SPECIE  255 

the  influence  of  new  sources  of  supply.  This  factor  has  played 
an  important  part  in  the  production  and  prices  of  all  the  metals, 
especially  in  modern  times;  as,  for  example,  in  regard  to  iron 
and  copper.  It  has  always  had  special  importance  with  the 
precious  metals,  because  of  that  amalgamation  of  old  and  new 
supplies  which  results  from  their  durability.  When  new  and 
rich  mines  have  been  discovered,  the  output  from  them  has  not 
displaced  existing  stocks,  but  has  simply  been  added  to  them. 
It  is  so,  also,  with  the  output  from  the  unsuccessful  mines. 
Though  poor  mines  may  have  been  unprofitable  to  those  exploit- 
ing them,  the  gold  and  silver  yielded  by  them  have  contributed 
permanently  to  the  amount  in  use.  Hence  the  monetary  stock 
at  any  given  time  has  been  a  jumble  from  rich  mines  and  poor 
mines;  ancient  supplies  from  forgotten  sources  have  mingled 
with  new  additions  from  well-known  regions;  there  has  been 
accidental  discovery  and  scientific  exploitation  ;  the  whole  finally 
constitutes  one  vast  homogeneous  mass,  exerting  its  influence 
on  value  through  its  total  quantity. 

§  2.  These  general  statements  can  be  illustrated  by  consider- 
ing the  history  of  some  of  the  great  changes  in  the  supply  of  the 
precious  metals. 

By  far  the  most  remarkable  change  in  recorded  history  took 
place  between  the  middle  of  the  sixteenth  and  the  middle  of  the 
seventeenth  century.  Then  the  production  and  supply  of  both 
gold  and  silver  were  revolutionized.  For  the  sake  of  simplicity, 
gold  has  been  chiefly  spoken  of  in  the  preceding  pages.  But 
until  comparatively  recent  times  silver  was  a  more  important 
monetary  metal  than  gold.  Gold  and  silver  were  used  inter- 
changeably at  the  period  of  this  great  revolution,  and  the  sup- 
plies and  the  values  of  both  may  be  treated  for  this  period  as  if 
they  were  one. 

During  the  Middle  Ages  and  the  Renaissance  specie  had  been 
comparatively  scarce.  Some  supplies  had  been  left  over  from 
the  days  of  the  Roman  Empire ;  and  there  was  some  production, 
especially  of  silver,  in  Germany,  Sweden,  Bohemia,  Spain. 
The  general  range  of  prices  was  low.  So  far  as  can  be  made 


256       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

out  from  a  comparison  of  the  commodities  dealt  in  then  and 
now,  prices  in  the  fifteenth  century  were  only  one  fourth  or  one 
fifth  of  what  they  were  in  the  nineteenth.  It  must  be  remem- 
bered, too,  that  payment  in  kind  was  still  largely  prevalent ; 
hence  the  supply  of  gold  and  silver  which  was  on  hand  served  to 
carry  on  exchanges  for  only  a  limited  part  of  the  commodities 
produced  and  used.  The  discovery  of  America  led  in  the 
sixteenth  century  to  a  sudden  enormous  increase  in  the  supply. 
The  conquest  of  Mexico  in  1519-1521  and  that  of  Peru  shortly 
afterward  enabled  the  rapacious  Spaniards  to  seize  large  accumu- 
lated treasures.  Even  more  important  was  the  production  from 
the  rich  mines  of  these  countries,  —  mines  partly  known  already 
to  the  natives,  partly  discovered  by  the  Spaniards.  By  far  the 
most  important  were  the  mines  at  Potosi,  discovered  in  1545. 
Silver  was  chiefly  produced,  and  it  was  in  the  form  of  silver  that 
the  monetary  supply  of  Europe  was  chiefly  increased.  In  the 
first  decades  of  the  sixteenth  century  the  total  production  of 
silver  had  been  on  the  average  1,500,000  ounces  a  year.  It  rose 
to  near  3,000,000  ounces  in  the  period  from  1521  to  1544,  and 
in  the  period  beginning  with  1545  (the  year  of  the  opening  of 
Potosi)  it  leaped  to  10,000,000  ounces  a  year.  About  the  last 
figure  it  remained  for  two  centuries  thereafter.1 

This  great  mass  of  new  specie  was  brought  to  Europe  by 
the  Spanish  treasure  fleets.  A  share  was  captured  on  the 
way  by  the  English  and  Dutch  buccaneers;  but  most  of 
it  reached  Spain,  and  thence  made  its  way  over  Europe. 
Very  large  amounts  never  went  into  circulation  in  Spain, 
but  were  sent  by  the  Spanish  monarchs,  especially  Charles 
V,  Philip  II,  and  Philip  IV,  to  meet  the  expenses  of  their 
armies  in  Italy,  Germany,  France,  and  the  Netherlands. 
Through  one  channel  or  the  other,  the  silver  and  gold  reached 
all  Europe.  In  part,  as  was  noted  in  the  preceding  chapter,  it 
simply  enabled  exchange  by  money  to  supersede  exchange  by 
barter;  it  percolated,  so  to  speak,  into  spaces  not  previously 

1  Figures  for  the  annual  production  of  the  precious  metals  are  given  regularly 
in  the  reports  of  the  United  States  Director  of  the  Mint. 


THE  COST  OF  SPECIE  257 

occupied.     But  even  with  this  absorption,  the  increase  in  quan- 
tity was  so  great  as  to  swell  the  amount  of  money  relatively  to 
the  commodities  exchanged,  and  so  to  bring  about  what  is 
known  as  the  price  revolution  of  the  sixteenth  century. 
The  total  supply  in  Europe  has  been  estimated  thus  :  l  — 


GOLD  (OUNCES) 

SILVEB  (OUNCES) 

In  1493.  . 

17,682,500 

225,050,000 

In  1544  

26,202,250 

295,458,500 

In  1600  :. 

38,322,800 

771  600  000 

In  1660  

48,225,000 

1  005  330  500 

Stated  in  terms  of  dollars,  this  means  that  the  stock  of  gold  and 
silver,  taken  together,  rose  from  about  $580,000,000  in  1493  to 
$1,620,000,000  in  1600  and  to  $2,500,000,000  in  1660.  By  the 
middle  of  the  seventeenth  century,  prices  had  risen  to  double 
or  treble  what  they  were  at  the  opening  of  the  sixteenth  century. 
The  change  worked  itself  out  chiefly  during  the  hundred  years 
from  1550  to  1650, — a  century  of  far-reaching  industrial  transfor- 
mation in  many  directions,  and  of  social  and  political  changes 
as  important,  all  complicated  and  affected  by  the  great  rise  in 
prices. 

The  great  advance  in  prices  —  the  fall  in  the  value  of  money 
—  was  due  unquestionably  to  the  increase  in  the  quantity  of 
specie.  But  it  would  be  misleading  to  speak  of  it  as  determined 
or  measured  by  a  corresponding  change  in  cost  of  production. 
The  miserable  laborer  —  more  than  half  slave  —  in  Peru  and 
Mexico  was  forced  to  his  work  in  the  mines  by  the  brutal 
Spaniard ;  great  quantities  of  specie  came  from  the  rich  mines ; 
but  it  would  be  absurd  to  speak  of  any  commercial  adjustment 
of  value  to  cost. 

1 1  take  these  figures  (converting  kilograms  into  ounces)  from  Wiebe's  Geschichte 
der  Preisrevolution  im  1 6.  und  17.  Jahrhundert,  p.  28 1 .  They  are  at  best  very  rough 
estimates.  The  figure  for  1493  (the  starting  point)  is  most  uncertain  of  all. 
Moreover,  the  estimates  are  for  the  total  metallic  stock,  not  for  the  monetary 
stock.  My  own  impression  is  that  the  increase  in  monetary  supply  itself  was 
greater  than  these  figures  indicate ;  but  one  can  have  nothing  more  than  an 
impression,  no  certain  knowledge, 
s 


258   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

By  the  middle  of  the  seventeenth  century  something  like  a  state 
of  equilibrium  had  been  reached.  The  supplies  of  specie  from 
the  mines,  it  is  true,  continued  to  be  as  large  as  they  had  been 
since  1545,  and  even  increased  somewhat  during  the  eighteenth 
century.  But  the  total  stock  on  hand  had  been  so  swelled  that 
the  continuing  additions  were  of  much  less  proportionate  effect. 
A  fair  degree  of  stability  in  value  had  come  from  the  durability 
of  the  accumulated  stock.  There  was,  moreover,  a  steady  advance 
of  population  and  wealth,  an  improvement  in  the  arts,  and  so  an 
increase  of  the  quantity  of  goods  presented  for  sale.  Hence 
during  the  second  half  of  the  seventeenth  century  and  the  greater 
part  of  the  eighteenth,  the  range  of  prices  was  tolerably  stable, 
with  rather  a  downward  than  an  upward  trend.  During  the 
first  half  of  the  nineteenth  century,  the  trend  of  prices  was  dis- 
tinctly, though  not  rapidly,  downward.  This  downward  move- 
ment was  not  due  to  any  decreased  supplies  of  specie ;  on  the 
contrary,  the  production  of  silver  increased  considerably,  and 
that  of  gold  held  its  own.  But  the  great  expansion  which  had 
followed  the  industrial  revolution  of  the  eighteenth  century  was 
in  full  swing,  and  the  quantity  of  transactions  increased  more 
rapidly  than  the  monetary  supplies. 

§  3.  Another  far-reaching  change  in  the  production  of  precious 
metals  set  in  about  1850.  It  was  gold  that  now  was  chiefly 
affected.  Gold  deposits  of  extraordinary  richness  were  discovered 
almost  simultaneously  in  California  and  Australia.  The  pro- 
duction rose  from  an  annual  average  of  something  like  500,000 
ounces  in  1820-1840  to  an  annual  average  of  over  6,000,000 
ounces  in  1851-1860 ;  and  this  rate  of  production  was  main- 
tained, with  no  marked  changes,  for  nearly  half  a  century. 
Stated  in  terms  of  dollars,  the  annual  gold  supply  rose  from, 
roughly,  $10,000,000  in  1820-1840  to  about  $125,000,000  in  1850- 
1895.  During  the  twenty-five  years  from  1850  to  1875,  as 
much  gold  was  produced  and  added  to  the  world's  stock  as  had 
been  produced  during  the  three  and  a  half  centuries  from  1492 
to  1850.  If  the  dividing  line  be  put  at  1840  (for  there  was  al- 
ready a  marked  increase  from  1840  to  1850),  it  appears  that  the 


THE  COST  OF  SPECIE  259 

gold  product  between  1840  and  1875  markedly  exceeded  that 
between  1492  and  1840.  The  change  in  the  monetary  stock 
was  of  course  much  greater.  Of  the  amount  which  had  been 
produced  between  1492  and  1850,  a  large  proportion  had  been 
lost  by  absorption  in  the  arts,  by  abrasion,  and  (so  far  as  Euro- 
pean countries  were  concerned)  by  exportation  to  the  eastern 
hemisphere.  The  total  monetary  stock  of  gold  in  Europe  was 
in  1850  about  38,000,000  ounces,  or,  in  terms  of  dollars,  about 
$780,000,000.  So  sharp  was  the  increase  in  production  that, 
by  1860,  the  total  monetary  stock  (after  allowing  for  industrial 
consumption  during  the  decade)  was  reckoned  at  88,000,000 
ounces,  or  about  $1,800,000,000.  In  ten  years  the  monetary 
supply  of  gold  had  doubled.1 

The  effect  on  prices  after  1850,  however,  was  not  comparable 
to  that  of  the  earlier  period.  Price  did  indeed  rise  after  1850 
in  Europe  and  the  United  States,  and  remained  at  a  com- 
paratively high  level  for  about  a  quarter  of  a  century.  But 
the  advance  was  one  of  only  twenty  or  thirty  per  cent.  No 
such  revolution  in  prices  took  place  as  that  which  followed  the 
discovery  of  America. 

The  explanation  of  this  slight  effect  from  a  cause  apparently 
so  powerful  is  to  be  found  in  several  directions.  There  was  a 
steady  increase  in  the  demand  for  money.  The  civilized  world 
was  progressing  fast,  and  the  volume  of  commodities  produced 
and  exchanged  was  enlarging.  Next,  —  and  probably  this 
was  more  important  in  the  decades  immediately  after  1850,  — 
the  new  supplies  of  gold  were  added  to  an  existing  stock  com- 
posed, not  of  gold  only,  but  of  both  gold  and  silver,  and  of  the 
two  metals  coined  and  used  with  equal  freedom.  In  that  stock 
silver  had  been  the  major  constituent  in  1850.  Finally,  the  new 
supplies  of  gold  in  part  served  simply  to  displace  silver  Of 
this  process  of  substitution  more  will  be  said  when  the  topic  of 
bimetallism  is  reached.2  It  suffices  here  to  note  that  in  France 

1  I  take  these  figures  from  Soetbeer's  Materials  on  the  Silver  Question,  1887 
(English  translation,  p.  150). 
1  In  the  next  following  chapter. 


260       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

and  other  bimetallic  countries,  much  gold  simply  took  the 
place  of  silver,  the  silver  being  lost  to  civilized  countries  by 
steady  exportation  to  the  Orient.  So  far  as  such  substitution 
went  on,  the  new  supplies  of  gold  served  to  alter  the  com- 
position of  the  metallic  money  of  Europe,  but  not  to  add  to  its 
total  volume.  There  was  indeed  a  net  addition  to  the  total 
volume,  and  an  addition  more  than  in  proportion  to  the  greater 
volume  of  commodities.  Hence  a  rise  in  prices  took  place; 
but  only  to  that  moderate  extent  which  has  been  indicated. 

§  4.  We  pass  over  for  the  present  the  period  of  falling  prices 
in  the  last  quarter  of  the  nineteenth  century,  since  that  period 
can  be  best  considered  in  connection  with  bimetallism.  In 
the  production  of  gold,  another  great  change  has  been  taking 
place  during  the  closing  years  of  the  nineteenth  century  and 
the  opening  years  of  the  twentieth.  The  annual  output  of 
gold  had  remained  nearly  stationary  after  the  Californian  and 
Australian  discoveries  of  1850.  During  the  decade  1880-1890, 
there  had  been  some  slight  tendency  to  decline,  but  no  marked 
change.  Thereafter  production  rose  rapidly ;  it  doubled  before 
the  close  of  the  nineteenth  century;  it  quadrupled  within  five 
years  thereafter.  In  1880-1890  the  annual  production  had 
been  on  the  average  something  like  one  hundred  millions  of 
dollars.  In  the  year  1900  it  was  over  250,000,000 ;  in  1910, 
455,000,000.  The  change  was  almost  miraculous.  The  total 
production  of  gold  was  greater  during  the  twenty  years  1891- 
1910,  than  it  was  during  the  forty  years  1850-1890 ;  and  during 
each  of  these  periods  it  was  much  greater  than  it  had  been 
during  the  centuries  that  elapsed  between  1493  and  1850.1 

This  vast  addition  to  the  stock  of  gold  was  the  foundation 
of  the  rise  in  prices  which  took  place  in  the  Western  nations, 
and  indeed  the  world  over,  during  the  first  decade  of  the  cen- 
tury (1900-1910).  What  other  causes  were  at  work,  and  to 
what  extent  the  simple  quantity  theory  must  be  modified  hi 

1  The  production  of  gold  may  be  grouped  as  follows :  — 

Aggregate  during  the  257  years,  1493-1850 152,000,000  ounces. 

Aggregate  during  the    40  years,  1850-1890 232,000,000  ounces. 

Aggregate  during  the    20  years,  1891-1910 284,000,000  ounces. 


THE  COST  OF  SPECIE  261 

accounting  for  the  higher  prices,  need  not  here  be  considered. 
The  increase  in  the  gold  supply  was  the  dominant  cause.  It 
cannot  be  foreseen  how  far  that  increase  will  go,  or  how  far  it 
will  contribute  to  yet  higher  prices.  One  circumstance  which 
operated  as  a  drag  on  the  upward  movement  of  prices  in 
1850-1875  was  not  present,  namely,  the  displacement  of  silver. 
Gold  had  won  its  victory.  Silver  had  been  displaced  once  for 
all,  or  at  least  reduced  to  a  subsidiary  place.  The  additions 
to  the  gold  supply  were  in  the  main  net  additions  to  the  mone- 
tary stock  of  Western  countries,  and  additions  of  extraordinary 
amount.  No  doubt,  the  great  and  steady  growth  in  the  volume 
of  commodities  brought  an  increasing  demand  to  meet  the 
increasing  supplies  of  gold;  but  whether  the  demand  grew  in 
proportion  must  be  doubted. 

The  new  supplies  of  gold  were  derived,  as  already  remarked, 
chiefly  from  low-grade  ores;  that  is,  from  great  deposits  of 
ore  having  a  very  low  content  of  gold,  but  capable  of  being 
worked  systematically  on  a  great  scale.  It  is  profitable  to 
mine  ore  which  yields  only  $10  (half  an  ounce)  to  the  ton ;  that 
is,  ore  which  contains  gold  in  the  proportion  1 :  75,000.*  The 
most  notable  source  of  this  kind  is  in  South  Africa,  where  the 
mines  of  the  Transvaal  tempted  the  fortune  hunters  and  led 
to  the  subjection  of  the  sturdy  Boers.  The  so-called  reef 
there  is  of  great  extent  and  calculable  richness.  For  a  con- 
siderable time  the  Transvaal  mines  alone  produced  annually 
nearly  as  much  as  the  world's  annual  output  in  the  richest 
period  of  the  Californian  and  Australian  discoveries.  Similar 
deposits  are  worked,  by  the  same  improved  methods,  in  the 
United  States,  and  indeed  in  all  parts  of  the  world.  American 
mining  engineers  and  managers  have  been  foremost  in  this 
march  of  improvement.  As  a  result,  the  efficiency  of  labor  in 
producing  specie  has  been  increased  to  the  same  degree  as,  nay, 
of  late  to  a  greater  degree  than  in  producing  coal  or  iron  or  most 
manufactured  commodities. 

1  There  are  even  mines,  worked  with  handsome  profit,  in  which  the  ore  con- 
tains only  $2.50  gold  to  the  ton,  or  one  part  in  300,000. 


262   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

It  is  obvious  that  any  uniform  increase  in  the  gold  supply, 
even  though  great,  tends  to  become  progressively  less  in  its 
effect.  Each  increment  enlarges  permanently  the  existing  stock ; 
and  the  succeeding  increments,  though  equally  great,  are  less  in 
proportion  to  the  stock  as  enlarged.  The  increase  in  supply 
takes  place  by  arithmetical  progression ;  it  would  have  to  take 
place  by  geometrical  progression  in  order  to  continue  to  lift 
prices  at  the  same  rate  as  at  the  start.  The  monetary  supply  of 
gold  doubled  between  1850  and  1860.  But  after  1860,  the  stock 
on  hand  had  been  so  much  enlarged  that,  though  the  same 
annual  output  was  maintained,  the  rate' of  enlargement  in  the 
total  supply  was  much  relaxed.  When  a  stream  of  water  floods 
a  valley,  the  first  inflow  raises  the  level  very  fast.  As  the 
inflow  continues,  there  is  a  widening  of  the  area  over  which 
the  water  spreads,  and  the  same  addition  to  the  supply  pro- 
duces a  steadily  lessening  effect  in  raising  the  surface.  So  it 
is  with  an  increase  in  the  supply  of  the  money  metals. 

§  5.  At  the  beginning  of  this  chapter  it  was  said  that  w.e 
should  expect  gold  to  be  governed  in  value  by  the  principles 
that  apply  under  varying  costs  and  diminishing  returns.  That 
is,  we  should  expect  value  to  be  determined,  in  the  long  run, 
by  cost  at  the  poorest  source  of  supply,  or  at  the  marginal 
mine.  In  fact,  however,  over  periods  as  long  as  it  is  commonly 
worth  our  while  to  consider,  the  relation  is  more  nearly  the  op- 
posite. It  is  not  so  true  that  cost  at  the  marginal  mine  governs 
value,  as  it  is  that  current  value  determines  what  sort  of  mine 
shall  remain  in  operation  and  shall  become  the  marginal 
mine. 

This  inverted  relation  is  due  to  the  operation  of  two  of  the 
factors  noted  in  the  first  section :  the  durability  and  conse- 
quent large  accumulated  stock  of  gold,  and  the  irregularity  in 
the  discovery  of  new  supplies.  The  great  stock  on  hand  deter- 
mines or  at  least  underlies  the  value  of  the  specie.  Those 
mines  that  are  workable  at  this  value  continue  to  yield  their 
supplies.  Those  that  are  not  workable  at  this  value  cease. 
(We  disregard  here  the  aleatory  character  of  gold  mining, 


THE  COST  OF  SPECIE  263 

which  causes  no  little  production  even  at  a  loss.)  The  richer 
mines,  which  yield  a  large  profit  at  current  values,  a  fortiori 
continue  to  yield  supplies;  very  probably  the  major  part  of 
the  annual  output  comes  from  them.  Value  does  not  accom- 
modate itself  to  cost  at  their  hands,  because  of  the  slow  in- 
fluence of  the  annual  yield  on  the  total  stock.  A  decline  in 
the  value  of  gold  —  that  is,  a  general  rise  in  prices  —  makes 
things  harder  for  the  poorer  mines,  and  some  of  them  cease 
operations.  But  cessation  on  their  part  may  have  but  a  neg- 
ligible effect  on  the  total  stock.  Search  for  new  mines  is  con- 
stantly going  on.  All  new  ventures  add  something  to  the 
annual  yield,  even  though  many  of  them  are  unprofitable  and 
therefore  only  of  temporary  effect.  Some  of  the  ventures  are 
highly  successful,  and  on  occasions  —  as  in  California  and 
Australia  in  1850,  and  in  the  Transvaal  since  1890 — contribute 
huge  supplies  suddenly.  It  might  be  expected  that  a  high  value 
of  gold  (that  is,  low  prices)  would  stimulate  the  search  for  it, 
a  low  value  (high  prices)  dampen  the  search.  Some  such  tend- 
encies there  doubtless  are.  But  they  are  overshadowed,  in 
their  effects  on  total  stock  and  on  value,  by  the  steadiness  of 
the  total  stock  and  the  irregularities  of  discovery  and  exploita- 
tion. Historically,  therefore,  it  is  very  difficult  to  discover 
any  but  the  loosest  connection  between  the  cost  of  gold  and  its 
value.  Over  long  periods  —  for  generations  at  a  time  —  the 
value  of  the  metal  determines  which  among  the  mines  are  able 
to  hold  their  own.  It  is  not  these  mines  that  determine  the 
metal's  value. 

This  proposition,  at  all  events,  seems  now  to  hold  good  of 
gold.  Until  very  recent  times  it  held  good  of  silver  also.  During 
the  great  silver  flood  which  followed  the  discovery  of  America, 
the  mines  in  Germany  and  other  parts  of  Europe  had  to  ac- 
commodate themselves  to  the  new  range  of  prices  and  the  new 
value  of  silver.  Those  which  were  no  longer  profitable  under 
these  new  conditions  ceased  operations;  and  the  silver  pro- 
duction of  Europe  shrank  sensibly  during  that  period.  Within 
the  last  thirty  or  forty  years,  however,  silver  has  been  put 


264        MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

into  a  very  different  position.  It  has  become,  in  the  main, 
an  industrial  metal,  like  tin,  copper,  nickel ;  and  its  value  is 
determined  now  by  causes  essentially  the  same  as  those  acting 
on  these  other  metals.  This  great  change  in  the  position  of 
silver  is  the  main  subject  of  the  following  two  chapters. 


CHAPTER    20 
BIMETALLISM 

§  1.  In  the  preceding  pages  no  attempt  was  made  to  consider 
the  relations  between  gold  and  silver.  The  supply  of  specie 
was  treated  as  if  gold  and  silver  constituted  a  homogeneous 
mass.  Throughout  most  of  monetary  history,  however,  prob- 
lems and  difficulties  have  arisen  in  the  endeavor  to  treat  the 
two  metals  as  homogeneous.  These  difficulties  became  accen- 
tuated in  the  nineteenth  century,  and  finally  resulted,  at  the 
close  of  that  century,  in  the  displacement  of  silver  from  the 
position  of  a  freely  coined  money  metal.  This  change,  one  of 
the  most  notable  in  monetary  history,  was  brought  about  in  a 
surprisingly  short  space  of  time.  For  long  centuries  silver 
had  been  freely  coined,  and  had  been  the  more  important 
monetary  metal;  it  was  discarded  from  this  use  in  the  brief 
course  of  one  generation. 

Both  before  and  after  the  great  inflow  of  specie  from  the 
Spanish-American  mines,  the  two  metals  were  used  interchange- 
ably. Silver  was  relatively  the  more  plentiful,  and  the  more 
commonly  used.  It  was  entirely  possible  to  coin  each  metal 
independently,  and  let  the  two  sorts  of  pieces  circulate  together, 
but  not  on  any  common  basis.  Yet  it  was  highly  convenient 
to  link  them  together  in  some  way,  so  arranging  their  denomi- 
nations that  they  could  be  used  interchangeably.  Gradually 
the  double  standard  system  developed :  both  metals  were 
manufactured  into  coins  of  the  same  or  similar  names  and 
denominations.  The  method  is  illustrated  in  the  system  of 
the  United  States.  The  silver  dollar  contains  371  £  grains  of 
pure  silver,  or  412?  grains  of  silver  -^  fine.  The  gold  dollar 
contains  (or  rather,  if  coined,  would  contain)  23.22  grains  of 
pure  gold,  or  25.8  grains  of  gold  T$  fine.  Their  weights  are  to 

265 


266   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

each  other  as  16  to  1  (15.988  is  the  precise  figure,  commonly 
spoken  of  as  16).  This  is  the  coinage  ratio;  the  silver  dollar 
contains  sixteen  times  as  much  pure  metal  as  the  gold  dollar. 
Similarly,  in  France,  the  five-franc  piece  of  silver  contains 
347.22  grains  of  pure  silver,  and  the  corresponding  piece  of 
gold  would  contain  22.4  grains  of  pure  gold.  The  coinage  ratio 
in  this  case  is  15j  to  1. 

Under  the  pure  and  simple  double  standard  both  metals 
are  freely  coined.  Any  holder  of  silver  bullion  can  bring  it  to 
the  mint,  and  have  it  manufactured  into  coin  without  limit 
of  quantity ;  and  the  holder  of  gold  bullion  has  the  same  right. 
Moreover,  all  coins,  whether  silver  or  gold,  are  made  full  legal 
tender  for  the  payment  of  debts ;  that  is,  of  debts  contracted, 
as  most  debts  are,  simply  in  terms  of  so  many  dollars  or  francs. 
These  two  elements  —  free  coinage  and  full  legal  tender  —  are 
the  essentials  of  the  complete  double  standard. 

§  2.  When  the  double  standard  is  adopted,  the  question 
arises  whether  the  ratio  at  which  the  metals  are  coined  by  the 
mint  and  are  thus  given  purchasing  power  in  the  form  of  money, 
conforms  to  their  relative  value  as  bullion.  If  at  the  mint 
16  ounces  of  silver  are  coined  in  the  market  into  as  many  dollars 
as  1  ounce  of  gold;  and  if,  as  bullion,  15  or  15^  ounces  of 
silver  can  be  sold  at  a  price  equivalent  to  1  ounce  of  gold,  — 
no  one  will  bring  silver  to  the  mint.  The  silver  will  be  more 
valuable  as  bullion  than  as  coin ;  and  experience  proves  that  a 
very  small  fraction  of  difference  suffices  to  decide  that  the 
metal  shall  not  be  presented  for  coinage.  If,  on  the  other  hand, 
silver  as  bullion  can  be  sold  only  at  the  rate  of  16i  or  17  ounces 
of  silver  for  1  ounce  of  gold,  no  one  will  bring  gold  to  the  mint. 
The  holder  of  an  ounce  of  gold  can  get  for  it  at  the  mint  only 
as  many  coined  dollars  as  he  can  get  for  16  ounces  of  silver. 
By  exchanging  his  gold  in  the  market  for  16i  or  17  ounces  of 
silver  bullion,  he  can  get  more  coined  dollars;  and  accord- 
ingly he  will  present  at  the  mint  silver  bullion  only.  To  repeat, 
a  very  small  variation  between  the  ratio  fixed  at  the  mint  and 
that  which  rules  in  the  open  market,  will  cause  one  or  the  other 


BIMETALLISM  267 

of  the  two  metals  to  be  the  sole  one  presented  at  the  mint 
for  coinage. 

The  metal  which  tends,  under  such  conditions,  to  be  pre- 
sented at  the  mint  is  said  to  be  overvalued.  The  metal  which 
is  not  presented,  and  which  indeed  may  be  subjected  to  the 
opposite  process  of  being  melted  into  bullion  from  coin,  is  said 
to  be  undervalued.  Strictly  speaking,  the  mint  regulations  do 
not  put  a  valuation  on  either  metal;  they  simply  state  the 
conditions  of  coinage.  But  the  regulations,  when  they  are 
those  of  the  complete  double  standard,  do  lay  down,  in  an 
effective  way,  a  relative  value.  Where  silver  is  coined  at  a 
ratio  of  16  to  1  with  gold,  and  silver  is  worth  in  the  market 
15  to  1  of  gold,  the  coinage  system  says  that  16  ounces  of 
silver  are  required  to  buy  as  much  as  1  ounce  of  gold;  the 
market  says  that  15  ounces  suffice.  Silver  is  given  a  higher 
value  in  the  market,  a  lower  value  by  the  mint;  by  the  mint 
it  is  undervalued.  And  where  silver  is  worth  17  ounces  in  the 
market,  it  is  overvalued  at  the  mint  if  coined  at  this  same 
ratio  of  16  to  1.  The  mint  then  says  that  16  ounces  of  silver 
are  required  to  buy  as  much  as  1  ounce  of  gold,  but  in  the 
market  17  ounces  are  needed  to  buy  as  much. 

That  metal  which  is  overvalued  will  tend  to  become  the 
sole  constituent  of  the  metallic  circulating  medium.  It  alone 
will  be  presented  at  the  mint  for  coinage.  This,  to  be  sure, 
will  tend  to  withdraw  it  pro  tanto  from  the  bullion  market; 
and  this  process  will  tend  to  raise  its  value  as  bullion.  Con- 
versely the  undervalued  metal,  not  being  presented  at  the 
mint  for  coinage,  will  tend  to  be  more  plentiful  in  the  market 
as  bullion ;  and  this  will  tend  to  lower  in  turn  its  value.  The 
offer  of  free  coinage  under  the  double  standard  thus  in  some 
measure  exercises  a  steadying  influence  on  the  relative  value  of 
gold  and  silver ;  a  fact  which,  as  will  presently  appear,  has  been 
of  no  small  importance  in  monetary  history.  But  if  there  be  a 
permanent  force  at  work  which  brings  about  a  continuing  differ- 
ence, even  though  a  slight  one,  between  the  market  valuation 

and  the  mint  valuation,  then  the  undervalued  metal  will  grad- 

\ 


268       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 


ually  go  out  of  circulation,  the  overvalued  metal  will  come 
more  and  more  into  circulation,  and  eventually  the  metallic 
money  will  consist  of  the  overvalued  alone.  If  there  is  a  con- 
siderable and  sustained  variation  between  mint  and  market 
valuations,  this  process  will  work  itself  out  very  quickly;  the 
cheaper  or  overvalued  metal  will  displace  the  other  in  a  very 
short  time. 

No  country's  history  presents  a  simpler  illustration  of  these 
principles  than  that  of  the  United  States.  When  our  coinage 
system  was  established  in  1792,  the  complete  double  standard 
was  adopted,  at  the  ratio  of  15  to  1.  That  ratio  was  chosen  after 
careful  inquiry;  but  it  proved  to  differ  from  the  market  ratio, 
which  was  about  15i  to  1.  At  least  this  ratio  was  accepted 
about  ten  years  later  for  the  coinage  system  of  France. 
Silver  accordingly  was  overvalued  at  the  United  States  mint, 
and  gold  was  undervalued.  No  gold  was  presented  for  coin- 
age, and  the  metallic  circulating  medium  consisted  wholly 
of  silver.1  In  1834,  in  consequence  of  various  causes,  — 

1  Silver  dollars  of  United  States  mintage  were,  in  fact,  little  used  in  this  earlier 
period.  The  coins  were  chiefly  of  foreign  mintage,  largely  Mexican  dollars, 
which  passed  current  at  rates  specified  by  law  for  their  receipt  in  payment  of 
public  dues.  The  foreign  coins  took  the  place  of  the  United  States  coins  be- 
cause they  were  abraded  or  light  weight.  (Note  what  is  said  in  §  3  about 
Gresham's  Law.) 

The  changes  in  the  coinage  system  of  the  United  States  are  shown  in  the 
following  table.  The  coinage  ratio,  it  must  be  remembered,  rests  on  the  relative 
weight  of  pure  metal  in  the  coins. 

UNITED    STATES    COINAGE 


GOLD  DOLLAR 

SILVER  DOLLAR 

YEAH 

Standard 

Standard 

RATIO 

Gold   (gross 
weight  of 

Fineness 

Pure  Gold 

Silver  (gross 
weight  of 

Fineness 

Pure 
Silver 

coin) 

coin) 

grains 

grains 

grains 

grains 

1792 

27.00 

916.66  / 
/lOOO 

24.75 

416 

892.4  / 
/1000 

37li 

15tol 

1834 

25.8 

899.225  / 
/1000 

23.2 

416 

" 

37li 

16.002  to  1 

1837 

25.8 

900/ 
/1000 

23.22 

412£ 

900/ 
/lOOO 

37li 

15.988  to  1 

The  pure  content  of  the  silver  dollar  has  remained  the  same  throughout,— 


BIMETALLISM  269 

partly  a  reaction  against  undue  use  of  paper  money,  partly  an 
irrational  desire  to  use  gold  because  of  the  discovery  of  what  were 
supposed  to  be  large  deposits  in  North  Carolina,  —  the  ratio 
was  abruptly  changed.  It  was  made  16  to  1.  It  overvalued 
gold  as  much  as  the  old  ratio  had  overvalued  silver.  Gold  alone 
was  now  presented  at  the  mint  for  coinage.  Silver  gradually 
drifted  out  of  circulation  and  out  of  the  country.  The  change 
was  virtually  from  a  silver  standard  to  a  gold  standard.  After 
the  California  gold  discoveries  in  1850,  the  change  became  pro- 
nounced. Great  quantities  of  gold  were  coined  at  the  mint, 
and  silver  quite  disappeared.  Arrangements  were  indeed  made 
(in  1853)  for  the  use  of  silver,  as  subsidiary  coin,  and  in  later 
years  its  coinage  into  legal  tender  dollars  was  resumed;  but 
these  later  modes  of  using  silver  present  new  questions,  of  which 
more  will  be  said  shortly. 

§  3.  The  tendency  of  the  overvalued  metal  to  drive  out  the 
undervalued  is  often  termed  Gresham's  Law.  The  name  is 
derived  from  a  Sir  Thomas  Gresham  of  the  sixteenth  century, 
who  gets  undeserved  fame,  as  if  he  had  been  the  discoverer  of 
the  tendency.  The  "law"  is  simply  the  commonplace  fact,  long 
recognized,  that  where  coins  of  different  bullion  value  circulate 
side  by  side,  the  poorer,  if  there  be  enough  of  them,  will  displace 
the  better.  The  cheaper  money  metal  will  be  used  by  preference 
in  presentation  at  the  mint  and  in  making  payments ;  the  dearer 
will  be  used  by  preference  in  the  arts  or  for  bullion  purposes. 

An  important  illustration  of  this  tendency  is  in  the  displace- 
ment of  full-weight  coins  by  light-weight  or  abraded  coins  of  the 
same  metal.  Until  very  recent  times  the  machinery  for  manufac- 
turing coins  worked  slowly  and  somewhat  imperfectly.  It  was 
difficult  to  turn  out  a  great  many  coins  rapidly ;  and  the  coins 

371i  grains  of  fine  silver.  The  change  in  ratio  was  accomplished  in  1834  by 
lessening  the  amount  of  pure  metal  in  the  gold  dollar.  In  1837  further  minor 
changes  were  made,  bearing  chiefly  on  the  proportions  of  alloy  in  the  coins. 
These  proportions  had  previously  been  irregular.  The  fineness  was  now  made 
•fa  for  both  gold  and  silver,  and  at  the  same  time  a  slight  addition  was  made 
to  the  pure  content  of  the  gold  dollar,  making  a  trifling  change  in  the  coinage 
ratio. 


270   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

minted  not  only  were  subject  to  ordinary  abrasion,  but,  in  con- 
sequence of  uneven  mintage,  were  specially  subject  to  clipping. 
New  and  good  coins  were  therefore  likely  to  be  picked  out  for 
use  in  the  arts  or  for  exportation,  while  only  the  poorer  pieces 
remained  in  circulation.  Such  seems  to  have  been  the  common 
situation  of  silver  coins  until  far  into  the  nineteenth  century. 
Silver  com,  because  of  its  more  frequent  use,  is  more  subject  to 
abrasion  than  gold.  It  is,  moreover,  more  likely  to  pass  current 
and  to  remain  in  circulation,  even  though  abraded  ;  for,  since  it  is 
used  in  minor  transactions,  a  trifling  deficiency  in  bullion  con- 
tent, even  a  considerable  deficiency,  is  likely  to  be  disregarded. 
People  commonly  accept  the  smaller  pieces  as  they  are  offered 
in  payment,  without  troubling  themselves  to  inspect  them. 
Hence  —  to  give  an  example  —  in  the  United  States  during  the 
period  from  1792  to  1834,  when  silver  was  the  money  metal  in 
circulation,  foreign  silver  pieces  of  various  mintage  were  in  actual 
use.  These  foreign  coins  had  been  authorized  for  use  in  public 
payments,  because  at  the  beginning  no  United  States  mint  or 
coins  existed.  When  the  mint  was  established  and  coins  were 
issued  from  it,  the  new  coins  could  not  displace  the  foreign  pieces, 
being  full-weight  and  preferably  used  for  the  arts  or  exportation. 
Hence  the  coinage,  which  seemed  futile,  was  discontinued,  and 
only  the  more  or  less  inaccurate  foreign  coins  remained  in  circu- 
lation. Difficulties  of  a  similar  sort  were  long  encountered  in  all 
European  countries,  from  the  Middle  Ages  through  the  eighteenth 
century.  The  remedies  for  them  are  simple  :  first,  the  plentiful 
and  accurate  manufacture  of  full-weight  coin ;  second,  the 
withdrawal  of  all  legal  sanction  (such  as  receipt  in  payment  of 
public  dues)  from  other  coin;  and  third,  the  redemption  at  the 
public  charge  of  pieces  which  become  worn  by  ordinary  wear. 
It  was  formerly  common  to  enact  that  pieces  which  had  suffered 
in  weight  beyond  a  certain  tolerance  should  not  only  lose  their 
validity  as  legal  tender,  but  should  be  redeemed  at  the  mint 
merely  as  bullion,  not  at  their  face  value.  The  holder,  thus 
called  on  to  suffer  the  loss  in  value  from  abrasion,  tried  to  pass 
them  on  to  another  person.  Since  the  payment  of  ready  money  is 


BIMETALLISM  271 

usually  welcome  to  the  payee,  even  coins  much  abraded  remained 
indefinitely  in  circulation.  It  is  now  the  common  practise,  and 
the  sound  one  for  governments,  to  redeem  at  their  face  value  all 
coins  which  have  not  been  intentionally  clipped  or  sweated.1 
At  the  same  time,  the  machinery  for  providing  new  and  good 
coins  is  amply  adequate.  Hence  the  particular  troubles  here 
described  have  well-nigh  disappeared. 

§  4.  The  difficulties  commonly  experienced  under  the  double 
standard  have  caused  resort  to  another  mode  of  using  both  met- 
als together.  Gold  is  made  the  only  freely  coined  metal  and 
the  only  one  having  complete  legal  tender  quality,  and 
silver,  though  still  coined,  is  not  coined  freely,  but  in  limited 
amounts  and  solely  for  use  as  a  minor  coin.  This  method  was 
first  systematically  followed  by  England  when  she  adopted  the 
single  gold  standard  in  1816.  It  has  since  been  adopted,  so  far 
as  subsidiary  silver  is  concerned,  by  all  the  civilized  countries, 
and  has  become  a  normal  accompaniment  of  the  existing  gold 
standard  system. 

The  system  of  the  United  States  may  serve  as  an  example. 
The  high  value  of  gold  makes  it  unavailable  in  minor  payments. 
The  smallest  gold  piece  which  can  be  conveniently  used  is  the 
quarter  eagle  ($2.50),  corresponding  to  the  British  half  sover- 
eign, the  German  ten-mark  piece,  the  French  ten-franc  piece. 
Even  the  quarter  eagle  and  the  corresponding  coins  of  foreign 
countries  are  of  doubtful  serviceability ;  they  are  easily  lost  or 
overlooked,  and  are  subject  to  comparatively  rapid  abrasion. 
A  piece  of  the  sovereign  or  half  eagle  size  ($5)  is  the  smallest 
gold  coin  that  is  thoroughly  satisfactory.  Yet  a  multitude  of 
transactions  must  be  settled  with  money  of  smaller  denomina- 
tions. Silver  coins  are  convenient  in  sizes  from  the  ten-cent 
piece  to  the  dollar  piece.  For  the  smallest  transactions,  even 
silver  has  not  bulk  enough;  for  these,  resort  must  be  had 
to  nickel  and  copper. 

Under  the  complete  double  standard  it  may  well  happen  that, 
if  silver  is  undervalued,  all  the  silver  coin,  large  and  small, 

1  The  United  States,  however,  redeems  gold  coins  at  their  face  value  only 
where  the  depreciation  is  not  more  than  one-half  of  one  per  cent. 


272   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

will  disappear  and  that  an  inconvenient  scarcity  of  small 
change  will  ensue.  This  is  precisely  what  happened  in  the 
United  States  under  the  system  which  was  adopted  in  1834  and 
1837.  Silver  then  was  undervalued,  and  gold  gradually  took  its 
place.  When  finally  the  California  gold  poured  in  abundantly 
after  1850  and  gold  coinage  at  the  mint  assumed  large  dimensions, 
silver  completely  disappeared  from  circulation.  Hence  in  1853 
an  act  was  passed  which  created  the  subsidiary  system  in  this 
country.  Silver  coins  were  authorized,  —  half  dollars,  quarters, 
and  dimes,  —  containing  so  light  a  content  of  fine  silver  that 
no  one  would  be  tempted  to  export  them  or  to  melt  them  for  the 
arts.  The  silver  half  dollar,  for  instance,  was  made  to  contain 
(and  still  contains)  172.8  grains  of  fine  silver,  or  345.6  grains  for 
two  half  dollars.  The  silver  dollar,  whose  free  coinage  at  that 
time  was  still  authorized,  contained  (and  still  contains)  37li 
grains.  If  all  silver  coins  had  been  freely  minted  at  the  rate 
newly  adopted  for  the  half  dollars  and  for  the  other  subsidiary 
coins  (345.6  grains  to  the  dollar),  silver  would  then  have  been 
overvalued,  and  in  turn  would  have  displaced  gold.  But  some- 
thing very  different  from  free  coinage  was  put  into  operation. 
No  private  person  was  entitled  to  present  silver  at  the  mint  for 
conversion  into  small  coin.  The  government  itself  bought  the 
silver  bullion  in  the  market,  and  alone  arranged  for  its  coinage. 
The  amount  which  the  government  thus  bought  and  coined  was 
limited  to  the  quantity  supposed  necessary  to  meet  the  needs  of 
small-change  transactions.  Thus  the  silver  coins  would  not  be 
exported,  and  yet  would  not  displace  gold.  To  guard  against 
possible  abuse,  it  was  further  provided  that  the  subsidiary  coin 
should  be  legal  tender  only  up  to  a  limited  sum,  now  fixed  at  $10. 
Obviously,  the  government  makes  a  profit  by  an  operation  of 
this  sort.  The  overvalued  silver  coins  are  paid  out  by  the  gov- 
ernment in  its  ordinary  disbursements,  or  are  exchanged  by  it  for 
full-value  gold.  In  either  case  there  is  a  profit.  This  also  is 
often  called  a  "seigniorage,"  though  it  differs  in  important 
respects  from  the  seigniorage  which  may  be  charged  on  the 
freely  coined  and  full-value  pieces. 


BIMETALLISM  273 

Such  are  the  essential  principles  of  subsidiary  coinage.  Sub- 
stantially the  system  had  long  been  followed  as  to  the  copper 
and  nickel  coins  adapted  for  petty  transactions.  These  have 
been  token  coins  ever  since  gold  and  silver  came  to  be  used  as 
the  standard  metals.  In  fact,  the  underlying  principle  —  an 
artificial  value  due  to  limitation  of  quantity  —  was  followed,  or 
attempted  to  be  followed,  in  the  "  billon  "  coins  common  in 
Europe  from  the  Middle  Ages  until  the  first  part  of  the  nine- 
teenth century.  These  were  pieces  in  denominations  for  small 
transactions,  having  some  percentage  of  silver,  but  chiefly  alloy, 
issued  by  kings  and  princes  primarily  for  profit,  and  given  a 
circulation  within  their  territories.  The  issues  were  often  ex- 
cessive ;  the  opportunity  for  profit  was  abused.  In  this  regard, 
as  in  so  many  others,  coinage  practise  during  the  nineteenth 
century  was  greatly  improved,  and  now  is  well-nigh  perfected. 
No  state  now  coins  subsidiary  pieces,  whether  silver  or  nickel 
or  copper,  with  a  view  primarily  to  profit.  The  profit  accrues 
because  it  is  incident  to  the  best  method  of  providing  a  conven- 
ient medium  for  small  transactions. 

The  regulation  of  subsidiary  coin  is  carried  on  with  variations 
of  detail  in  different  countries.  The  quantity  coined  is  some- 
times fixed  at  so  much  per  head  of  population.  Thus  in  Ger- 
many subsidiary  silver  is  minted  at  the  rate  of  15  marks  (for- 
merly 10  marks)  per  head  of  population ;  in  France  at  the  rate 
of  7  francs  (formerly  6  francs)  per  head.  In  Great  Britain  no 
specific  limit  is  set ;  the  Bank  of  England  arranges  for  the  coin- 
age of  such  amounts  as  experience  from  time  to  time  shows  to  be 
needed.  In  the  United  States,  also,  no  limit  is  set. 

To  prevent  any  possible  depreciation  of  the  subsidiary  coin, 
it  is  usually  redeemable  at  its  face  value  by  the  government 
treasuries  when  presented  in  reasonable  quantity.  Thus  in  the 
United  States  subsidiary  silver  coins  are  redeemable  when  pre- 
sented in  sums  of  $20,  in  Germany  when  presented  hi  sums  of 
200  marks.  The  same  object  is  accomplished  by  receiving  them 
without  limit  of  quantity  in  payment  of  public  dues,  as  is  done  in 
France. 

T 


CHAPTER  21 

BIMETALLISM,  continued.    THE  DISPLACEMENT  OF 

SILVER 

§  1.  We  turn  now  to  a  consideration  of  the  relation  between 
silver  and  gold  during  the  nineteenth  century  and  to  the  train  of 
events  which  ended  in  the  virtual  discarding  of  silver  and  the 
general  adoption  of  the  single  gold  standard. 

The  double  standard,  as  has  already  been  said,  prevailed  over 
almost  all  Europe  until  very  recent  times.  It  was  chosen  by  the 
United  States,  in  1792,  as  the  normal  system.  It  was  maintained 
by  France  when  in  1803  she  established  her  present  system  of 
decimal  coins.  In  England,  it  is  true,  the  single  gold  standard, 
with  silver  for  subsidiary  coins  only,  was  adopted  in  1816. 
England  had  had,  through  the  eighteenth  century,  a  nominal 
double  standard,  with  a  circulation  composed  in  fact  chiefly  of 
gold.  In  1816  the  gold  standard  was  formally  and  definitively 
established.  But  on  the  continent  of  Europe  in  general  the 
double  standard  prevailed,  with  a  stock  of  metallic  money  made 
up,  as  a  rule,  chiefly  of  silver.  France  alone  had  a  circulation  in 
which  gold,  though  by  no  means  the  largest  constituent,  yet  was 
important  side  by  side  with  silver.  That  great  country  emerged 
from  the  wars  of  the  Napoleonic  period  in  a  prosperous  state ; 
and  her  greatness,  continued  prosperity,  and  her  large  stock  of 
both  metals  had  an  important  influence  on  monetary  history 
for  over  half  a  century. 

It  has  already  been  said  that  the  very  existence  of  the  double 
standard  tends  to  bring  the  relative  values  of  gold  and  silver 
toward  the  ratio  chosen.  When  a  supply  of  the  overvalued 
metal  is  attracted  to  the  mint,  so  much  less  of  it  is  left  in  the 
open  market.  Its  value  tends  to  rise,  it  becomes  less  overvalued, 
perhaps  ceases  to  be  overvalued  at  all.  When,  on  the  other 

274 


THE   DISPLACEMENT  OF  SILVER  275 

hand,  a  supply  of  the  undervalued  metal  is  melted  or  exported, 
so  much  more  of  it  comes  on  the  market.  The  additional  sup- 
ply tends  to  lower  its  value,  and  the  market  ratio  comes  nearer 
to  the  mint  ratio.  A  country  having  a  double  standard  may  be 
said  to  be  in  the  position  of  one  who  offers  to  buy  and  sell  at 
its  coinage  ratio  (say  15?  to  1)  any  quantity  of  gold  and  silver 
that  may  be  offered.  This  is  not  literally  the  case ;  the  country 
does  not  directly  buy  gold  and  silver  bullion.  But  its  free 
coinage  of  both  is  tantamount  to  purchase,  so  long  as  a  supply 
of  both  metals  remains  in  circulation,  and  the  substitution  of 
one  for  the  other  can  actually  take  place.  When  once  either 
metal  has  completely  displaced  the  other,  this  consequence  no 
longer  appears. 

Some  effect  of  this  sort  was  produced  by  France  during  the 
second  quarter  of  the  nineteenth  century ;  and  a  marked  effect 
was  produced  in  the  third  quarter.1  Whenever  the  price  of 
silver  fell  in  terms  of  gold,  silver  tended  to  be  sent  to  France  for 
coinage,  and  gold  tended  to  flow  out  of  France.  Whenever  the 
price  of  silver  rose  in  terms  of  gold,  gold  tended  to  be  sent  to 
France  for  coinage,  and  silver  tended  to  flow  out.  A  high  price 
of  silver  in  terms  of  gold  means,  of  course,  a  low  market  ratio, 
while  a  low  price  of  silver  means  a  high  ratio.2  During  the 
greater  part  of  the  period  from  1820  to  1850,  the  price  of  silver 
was  somewhat  lower  than  the  equivalent  of  the  French  ratio  of 
15|  to  1.  Silver  tended  to  flow  into  France ;  gold  tended  to  flow 

1  The  first  quarter  of  the  nineteenth  century  was  much  disturbed ;  moreover, 
our  information  as  to  the  flow  of  specie  into  and  out  of  France  is  exact  only 
after  1822.     Hence  the  narrative  in  the  text  is  confined  to  the  second  and  third 
quarters. 

2  The  relation  of  the  ratio  to  the  usually  quoted  price  of  silver  may  be  stated 
thus :  — 


AT  THE  RATIO  OF 

THE  PRICE  OF  FINE  SILVER  IN 
UNITED  STATES  MONET  is 

THE  PRICE  OF  BAR  SILVER 
(.925  FINE)  IN  BRITISH 
MONET  is 

16    :1 
15i:  1 
15   :1 

$1.2919  per  ounce 
1.3336  per  ounce 
1.3780  per  ounce 

58.93d.  per  ounce 
60.83     per  ounce 
62.86     per  ounce 

276   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

out.  The  French  circulation  then  consisted  chiefly  of  silver; 
the  proportion  of  gold  was  not  large,  and  a  very  great  substitu- 
tion would  have  led  to  the  complete  disappearance  of  gold. 
That  stage  was  nearly  reached,  but  not  quite.  France  was 
growing  in  population  and  wealth,  and  there  was  the  basis  for  a 
large  net  increase  in  the  stock  of  specie.  Much  of  the  added 
silver  made  its  way  into  circulation  without  displacing  gold,  and 
the  outflow  of  the  latter  metal,  though  it  seems  to  have  come 
very  near  to  exhausting  the  stock  in  circulation,  did  not  entirely 
do  so. 

After  1850  the  situation  abruptly  changed.  The  unexampled 
supplies  of  new  gold  from  California  and  Australia  were  poured 
into  the  world's  markets.  The  price  of  silver  rose ;  the  ratio  fell. 
It  became  advantageous  to  send  gold,  not  silver,  for  coinage  into 
France.  A  very  great  influx  of  gold  took  place,  amounting 
for  the  decade  1850-1860  to  over  three  thousand  million  francs 
($600,000,000).  A  corresponding,  though  by  no  means  an  equal, 
outflow  of  silver  took  place.  For  in  this  period,  as  in  that  pre- 
ceding, France  increased  her  metallic  stock,  with  the  difference 
that  now  the  addition  was  all  in  the  form  of  gold,  whereas  before 
it  had  been  chiefly  in  the  form  of  silver.  The  silver  which  was 
steadily  exported  from  France  tended  to  keep  down  the  price  of 
silver  bullion  in  the  market,  and  so  maintained  the  market  ratio 
not  far  from  15^  to  1,  though  now  with  a  tendency  to  a  figure 
lower  than  15^  rather  than  higher. 

The  bimetallic  regime  in  France  during  the  period  immediately 
following  1850  thus  served  to  steady  both  the  general  range  of 
prices  and  the  ratio  between  gold  and  silver.  A  great  part  of  the 
new  gold  simply  displaced  silver  in  France.  The  superseded 
metal,  again,  made  its  way  very  largely  to  the  East.  The  con- 
stant movement  of  specie  to  the  East,  which  has  already  been 
described,  happened  in  this  period  to  be  unusually  large.  There 
the  silver  was  absorbed  without  sensibly  affecting  prices  even 
in  those  regions.  The  free  opening  for  coining  both  metals  in 
France  has  been  justly  described  as  operating  like  a  parachute 
to  arrest  the  fall  in  the  value  of  gold.  Some  fall  —  that  is,  some 


THE  DISPLACEMENT  OF  SILVER  277 

rise  in  prices  —  did  indeed  take  place ;  but  it  was  less  sharp 
than  would  have  been  the  case  without  the  French  coinage 
influence. 

This  episode  has  been  cited  by  the  advocates  of  bimetallism, 
and  justly,  as  an  illustration  of  the  benefits  that  may  come  from 
their  system.  Some  critics  have  maintained  that  the  result 
failed  of  attainment,  so  far  as  concerns  the  relative  value  of  gold 
and  silver,  because  the  market  ratio  was  not  perfectly  steady. 
It  fluctuated,  tending  to  be  a  trifle  above  15£  to  1  before  1850, 
a  trifle  below  after  1850.  But  no  one  would  maintain  that  an 
unfailing  steadiness  at  the  price  exactly  equivalent  to  a  ratio  of 
15^  to  1  was  either  possible  or  in  any  significant  degree  desirable. 
It  suffices  if  a  reasonable  approach  to  steadiness  is  secured. 
Some  fluctuations,  according  to  the  changing  currents  in  inter- 
national trade  and  in  the  foreign  exchanges,  are  inevitable ; 
so  much  will  become  clear  when  at  a  later  stage  the  subject  of 
the  foreign  exchanges  is  taken  up.  In  essentials,  the  bimetallists 
can  point  to  the  French  experience,  certainly  during  the  period 
after  1850,  as  counting  in  favor  of  their  system. 

§  2.  Later  in  the  nineteenth  century  another  change  set  in, 
not  quite  so  abrupt  as  that  after  1850,  but  no  less  unexpected. 
The  production  of  gold  had  reached  its  maximum  about  1860, 
and  thereafter  barely  held  its  own.  The  inflowing  new  supplies 
were  still  very  great  as  compared  with  any  period  before  1850 ; 
but  they  spread  over  a  larger  area,  and  they  were  met  by  an  in- 
creasing volume  of  goods.  The  industries  of  the  civilized  world 
were  rapidly  expanding,  and  the  demand  for  money  on  the 
whole  kept  pace  with  the  supply.  On  the  other  hand,  a  change 
began  in  the  production  of  silver.  Great  discoveries  were  made 
in  the  United  States,  the  beginnings  of  an  increase  in  the  pro- 
ductiveness of  silver  mining  as  striking  as  that  which  had  taken 
place  in  gold  mining.  The  price  of  silver  in  the  market  fell 
slightly  about  1865.  Silver  no  longer  flowed  out  of  France,  and 
some  silver  flowed  in.  The  market  price  for  a  few  years  was 
equivalent  almost  exactly  to  the  ratio  of  15£  to  1.  Then  in  1873 
it  fell  more  sharply,  became  equivalent  to  a  ratio  of  16  to  1,  and 


278       MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

led  to  a  new  inversion  of  the  movement ;  gold  began  to  flow  out 
of  France  in  large  quantities,  and  silver  began  to  flow  in. 

This  inversion  proved  unwelcome.  Gold  had  come  to  be 
regarded,  reasonably  or  unreasonably,  as  .the  preferable  metal. 
The  practise  of  England,  the  leading  industrial  country,  was  the 
main  cause  of  this  preference.  The  German  Empire,  when  re- 
organizing its  currency  system  in  1871,  adopted  the  gold  standard 
once  for  all,  influenced  chiefly  by  the  English  example.  The 
coinage  of  the  United  States  had  been,  after  1850,  practically  on 
a  gold  basis.  France,  not  wishing  to  lose  her  gold,  in  1873 
stopped  the  free  coinage  of  silver.  In  this  measure  France 
no  longer  acted  alone.  With  other  countries  she  had  formed 
in  1865  the  Latin  Union ;  the  other  countries  being  Belgium, 
Switzerland,  Italy,  and  Greece.1  The  main  object  of  the  Union 
was  the  adoption  of  a  uniform  decimal  coinage  system,  based  on 
the  French  franc.  Complete  bimetallism,  with  free  coinage  of 
both  metals  at  15 1  to  1,  was  also  adopted ;  and  thereafter  all 
these  countries  had  to  act  in  common  in  their  mint  and  coinage 
legislation.  France  was  by  all  odds  the  most  important  power 
in  the  Union,  industrially  as  well  as  politically.  With  the 
checkered  and  interesting  history  of  the  Union  we  have  not 
space  to  deal.  It  served  a  useful  end  by  promoting  the  spread  of 
the  rational  franc  (decimal)  system,  but  it  led  to  much  friction 
and  inconvenience  between  the  adherent  countries.  So  far  as 
the  coinage  of  silver  was  concerned,  the  states  of  the  Latin  Union 
found  it  necessary  to  act  together.  The  decisive  steps  were 
taken  in  1873-1874 ;  then  free  coinage  ceased,  though  not  all  of 
silver  coinage.  In  1873  France,  acting  alone  at  first,  limited  the 
amount  of  five-franc  pieces  (that  is,  of  full-tender  silver)  which 
would  be  coined  at  the  mint.  Belgium,  also  acting  alone,  im- 
posed a  similar  limitation  in  1873.  In  1874,  the  Latin  Union, 
by  a  special  agreement,  prescribed  the  same  policy  for  its  mem- 

1  Greece  joined  the  Latin  Union  in  1868.  Spain  adopted  the  franc  system, 
but  did  not  join  the  Union.  Greece  and  Italy,  though  members,  have  counted 
for  less  than  the  other  countries,  because  their  currency,  during  practically  all 
of  the  time  when  action  regarding  silver  coinage  was  under  consideration,  was 
on  a  paper  basis.  As  to  the  working  of  paper  money,  see  Chapter  23,  below. 


THE  DISPLACEMENT  OF  SILVER  279 

bers,  the  amount  of  five-franc  pieces  to  be  coined  being  appor- 
tioned among  them.  Limitation  was  soon  followed  by  com- 
plete cessation.  In  1878  the  coinage  of  five-franc  pieces  was 
stopped;  and  it  has  never  been  resumed.  Bimetallism  came 
to  an  end. 

The  cessation  of  silver  coinage  left  the  metallic  circulation 
of  these  countries  in  a  situation  not  different  on  the  surface 
from  that  of  bimetallism,  yet  in  essentials  very  different. 
Gold  and  silver  coins  continued  to  circulate  side  by  side,  and 
maintained  the  relative  values  assigned  to  them  at  the  mint. 
The  silver  five-franc  pieces  were  not  subsidiary  coins;  they 
were  legal  tender  without  limit  in  payment  of  debts.  Yet  in 
important  respects  they  were  like  subsidiary  coin.  They  were 
no  longer  freely  minted ;  and  their  intrinsic  or  bullion  value 
was  different  from  that  which  they  had  as  coin.  The  price  of 
silver  bullion  continued  to  fall  after  1873  and  after  1878.  If 
free  coinage  of  silver  had  been  retained  in  France  and  the  Latin 
Union,  silver  would  have  been  presented  at  their  mints  in  larger 
quantities.  But  it  was  no  longer  accepted.  Gold  alone  was 
freely  coined.  The  silver  coins  were  as  good  as  the  gold  for 
payments  within  each  country,  and  indeed  throughout  the 
Union,  since  they  were  of  uniform  shape  and  content.  They 
were  (and  are)  legal  tender  without  limit;  and  they  were 
received  without  limit  in  payments  to  the  government  for 
taxes  and  other  dues.  Large  quantities  of  gold,  on  the  other 
hand,  were  also  in  circulation.  This  gold  had  to  be  in  use, 
in  addition  to  the  silver.  If  the  monetary  supply  had  been 
confined  to  the  silver  alone,  its  limited  quantity  would  have 
caused  prices  to  be  low ;  this  again  would  have  caused  imports 
to  be  small,  exports  to  be  large ;  money  would  have  flowed  hi ; 
and  the  only  kind  of  money  which  now  could  flow  in  was  gold.1 
The  silver  five-franc  pieces,  like  the  subsidiary  coin,  were  given 
an  artificial  value  by  the  limitation  of  their  quantity;  and 
their  value  conformed  to  that  of  freely  coined  gold. 

1  The  reasoning  here  anticipates  what  will  be  said  later  of  the  working  of 
international  trade.  But  this  part  of  the  theory  of  international  trade  is  so 
simple  that  its  bearing  will  be  readily  seen.  Compare  Book  IV,  Chapter  32, 


280   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

To  this  situation  in  France  and  the  Latin  Union,  never  estab- 
lished by  design,  but  reached  through  a  succession  of  unfore- 
seen steps,  the  name  "  limping  standard  "  has  been  applied. 
The  silver  coin,  though  intrinsically  of  less  value  than  the  gold, 
hobbles  along,  maintained  at  equality  by  being  coupled  with 
its  stronger  associate.  The  same  situation  has  developed  in 
other  countries  also,  partly  by  deliberate  action,  partly  by 
steps  taken  with  as  little  intent  as  in  the  Latin  Union  of  bring- 
ing about  a  limping  standard. 

§  3.  Germany  adopted  a  limping  standard  deliberately, 
though  only  as  a  transitional  measure.  As  has  just  been  said, 
her  gold  standard  was  adopted  in  1871,  when  a  uniform  coinage 
system  was  created  for  the  newly  established  empire.  The 
monetary  unit  was  the  mark,  whose  gold  content  is  nearly  that 
of  the  English  shilling ;  that  is,  the  twenty-mark  piece  is  not 
far  from  the  English  sovereign.  The  metallic  circulation, 
however,  had  been  before  that  time  chiefly  of  silver,  largely 
in  the  form  of  thaler  pieces  having  a  silver  content  equal  to 
that  of  about  three  and  one  half  francs.  These  thaler  pieces 
were  in  part  withdrawn  and  replaced  with  new  gold  pieces. 
But  in  part  they  were  left  in  circulation.  Their  complete 
replacement  with  gold  was  a  task  which  it  was  thought  best 
(and  wisely  so  thought)  to  carry  out  gradually.  No  new 
coinage  of  thalers,  of  course,  was  permitted.  Those  left  in 
circulation  were  declared  legal  tender  at  the  rate  of  three 
marks  for  the  thaler.  Notwithstanding  their  insufficient  in- 
trinsic value,  they  were  left  on  a  parity  with  gold  precisely 
like  the  silver  five-franc  pieces  of  the  Latin  Union,  —  by  the 
limitation  of  their  quantity,  by  their  full  legal  tender  power, 
and  by  their  acceptance  in  payment  of  all  public  dues. 

The  original  intention  had  been  to  leave  the  thalers  in  cir- 
culation only  during  a  comparatively  brief  period  of  tran- 
sition. It  was  expected  that  from  time  to  time,  as  they  were 
received  in  the  public  tills,  they  would  be  withdrawn,  melted 
into  bullion,  sold  as  such,  and  replaced  by  gold  coins.  This 
process,  indeed,  went  on  for  a  few  years.  But  after  1873  the 


THE  DISPLACEMENT  OF  SILVER  281 

price  of  silver  fell  sharply,  and  sales  of  the  metal  were  a  losing 
business.  Moreover,  the  advocates  of  bimetallism  bitterly 
opposed  the  sales.  The  German  government,  by  way  of 
partial  concession  to  the  bimetallists,  and  also  from  a  cautious 
desire  to  await  the  future  as  to  the  supplies  and  availability  of 
the  two  metals,  in  1879  stopped  the  withdrawal  of  the  thalers 
and  the  sale  of  the  bullion.  For  many  years  thereafter  the 
thalers  remained  in  circulation.  In  1900,  however,  steps  were 
finally  taken  toward  getting  rid  of  them,  though  in  a  way  some- 
what different  from  that  originally  contemplated.  The  act  of 
that  year  provided  for  their  retirement  by  gradual  recoinage 
into  subsidiary  money.  The  permissible  amount  of  subsidiary 
coin,  which  had  been  originally  ten  marks  per  head,  was  then 
raised  to  fifteen  marks ;  the  additional  quantity  of  such  coin 
was  to  be  got  by  using  the  old  thalers.  Most  of  the  thalers 
were  soon  recoined,  and  the  rest  will  disappear  as  the  increase 
of  the  population  of  Germany  calls  for  more  subsidiary  coin. 
Virtually,  the  limping  standard  has  ceased  to  exist  in  Germany. 

§  4.  In  the  United  States  a  result  exactly  similar  to  that 
in  France  has  been  brought  about,  without  intent,  through  a 
succession  of  compromises  and  half  measures.  The  history 
of  this  episode  cannot  be  fully  understood  until  price  move- 
ments and  paper  money  have  been  dealt  with.  So  far  as  the 
silver  situation  is  concerned,  it  will  suffice  to  state  briefly  the 
important  events. 

In  1873  the  coinage  of  silver  dollars  —  that  is,  of  the  full 
tender,  freely  coined  silver  —  was  dropped  in  the  United  States. 
It  was  in  this  year,  too,  that  France  suspended  free  coinage; 
but  the  coincidence  in  date  was  fortuitous.  The  United  States 
in  1873  had  only  paper  money  in  circulation;  depreciated 
paper,  or  so-called  fiat  money.  If  there  had  been  specie  hi 
circulation  (and  for  some  important  purposes  specie  was  in 
use,  though  not  in  active  circulation)  ,'that  specie  would  have  been 
gold.  After  the  coinage  changes  of  1834  and  1837,  and  the 
influx  of  new  gold  that  began  in  1850,  gold  alone  had  been  the 
real  basis  of  the  monetary  system.  The  existence  of  a  nominal 


282   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

double  standard  had  been  forgotten.  In  1873  the  coinage 
legislation  of  the  country  was  overhauled  and  consolidated,  in 
the  expectation,  realized  in  1879,  that  paper  money  would  be 
given  up  soon  and  a  specie  system  reestablished.  In  this 
revision  of  the  statutes,  the  silver  dollar  was  dropped  from  the 
list  of  coins  that  could  be  struck.  Therewith  bimetallism,  long 
obsolete  in  practice,  was  formally  ended  by  law.  The  change 
naturally  attracted  little  attention.  In  later  years,  when  a 
strong  agitation  for  renewed  use  of  silver  had  sprung  up,  the 
dropping  of  the  silver  dollar  was  often  called  "the  crime  of 
1873."  It  was  supposed  to  have  been  stealthily  done  by  per- 
sons interested  in  securing  the  gold  standard.  In  fact,  it  was 
done  quietly  because  nobody  at  the  time  thought  it  of  any 
moment. 

After  1873  a  period  of  depression  and  of  falling  prices  set  in. 
A  strong  party  in  the  United  States  wished  to  check  the  fall, 
and  welcomed  any  legislation  which  would  add  to  the  quantity 
of  money  in  use.1  For  a  generation,  there  was  agitation  for  a 
return  to  complete  bimetallism,  —  to  the  free  coinage  of  both 
gold  and  silver.  At  the  old  ratio  of  16  to  1,  and  at  the  market 
prices  of  silver  after  1873,  this  would  have  meant  the  actual 
coinage  of  silver  alone.  Yet  this  radical  step,  though  often  it 
seemed  impending,  was  never  taken.  By  way  of  compromise 
two  great  measures  were  passed,  each  providing  for  a  large 
though  limited  quantity  of  overvalued  silver  dollars. 

In  1878  the  so-called  Bland-Allison  Act  was  passed,  requiring 
the  monthly  purchase  by  the  government  of  not  less  than 
$2,000,000  worth  of  silver  bullion,  nor  more  than  $4,000,000 
worth ;  this  bullion  to  be  coined  into  dollars  of  the  old  content 
(412i  grains  of  standard  silver,  371i  grains  of  pure  silver). 
The  minimum  only  under  the  act  was  in  fact  bought  and 
coined,  —  $2,000,000  worth  of  silver.  The  number  of  dollars 
obviously  was  more  than  two  million  a  month.  If  the  price 

1  Not  a  political  party  is  here  meant ;  neither  Democrats  nor  Republicans 
were  consistent  in  their  policy  as  regards  silver  coinage.  The  silver  party  was 
made  up  of  adherents  from  both  political  parties. 


THE  DISPLACEMENT  OF  SILVER  283 

of  silver,  in  terms  of  the  money  which  the  government  used  in 
buying  it  (this  money  was  gold  after  1879)  happened  to  be 
low,  more  silver  bullion  could  be  bought  with  the  fixed  sum  of 
$2,000,000  and  a  larger  number  of  dollars  coined ;  if  the  price 
was  high,  less  bullion  could  be  bought,  and  less  dollars  coined. 
In  fact,  during  the  period  from  1878  to  1890,  when  this  act 
was  in  force,  the  outcome  was  the  monthly  coinage  on  the 
average  of  about  two  and  one  half  million  silver  dollars,  or 
thirty  million  a  year.  These  dollars  were  precisely  like  the 
French  five-franc  pieces;  overvalued,  limited  in  quantity, 
full  legal  tender,  and  in  every  respect  as  valid  for  payments  as 
gold. 

In  1890  a  second  measure  was  enacted,  again  a  compromise 
between  free  silver  coinage  and  rejection  of  silver.  Without 
entering  on  the  details  of  this  complicated  and  luckless  statute, 
it  may  be  said,  in  sum,  that  during  the  three  years  of  its  life 
(it  was  repealed  in  1893)  silver  was  purchased  by  the  govern- 
ment which  added  eventually  not  less  than  218,000,000  silver 
dollars  to  the  country's  money  supply.  Under  the  act  of 
1878,  there  had  been  coined,  in  round  numbers,  352,000,000 
such  dollars.  When  these  operations  finally  came  to  an  end, 
a  total  of  570,000,000  dollars  of  overvalued  silver  had  been 
injected  into  the  circulating  medium. 

It  is  not  so  much  in  the  form  of  coin,  as  in  that  of  the  silver 
certificate,  that  the  silver  has  made  its  way  into  actual  circula- 
tion. This  kind  of  paper  money,  as  the  name  indicates,  is 
merely  a  certificate  or  warrant  stating  that  so  many  silver 
dollars  (one,  two,  five,  as  the  case  may  be)  are  held  in  the 
government  vaults  and  will  be  paid  to  the  bearer  on  demand. 
Since  the  paper  representatives  are  for  most  people  more  conven- 
ient than  the  somewhat  bulky  dollars,  their  issue  has  greatly 
facilitated  the  actual  circulation  of  the  additional  money. 

Evidently  the  possibility  of  adding  these  hundreds  of  millions 
to  the  monetary  supply  of  the  United  States,  and  yet  keeping 
them  equal  in  value  to  gold,  has  rested  on  the  fact  that  this 
is  a  huge  country;  and  not  only  a  huge  country,  but  one 


284       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

whose  industry  advances  at  a  prodigious  rate.  In  addition  to 
the  silver,  there  are  other  forms  of  overvalued  money.  The 
bank  notes  and  government  notes  in  circulation,  which  will  be 
described  in  the  ensuing  chapters,  may  also  be  said  to  be  over- 
valued. An  indefinite  increase  in  the  quantity  of  all  this 
overvalued  or  "fiduciary"  money  would  mean  the  eventual 
expulsion  of  gold.  Indeed,  at  one  time,  between  1890  and  1893, 
the  rate  of  increase,  under  the  act  of  1890,  was  so  great  that 
gold  seemed  about  to  be  expelled;  and  this  probability  was 
one  cause  of  the  remarkable  crisis  of  1893,  and  of  the  repeal 
of  the  act.  In  recent  years,  the  population,  resources,  and 
industrial  output  of  the  United  States  have  advanced  by  leaps 
and  bounds.  The  quantity  of  commodities  offered  in  exchange 
for  money  has  risen  enormously.  Hence  gold  has  not  only 
remained  in  the  country,  side  by  side  with  the  silver,  but  the 
quantity  in  monetary  use  has  much  increased.  The  conse- 
quence has  been  that  the  overvalued  silver  has  had  its  stronger 
companion  side  by  side,  and  has  been  held  up  to  an  equal 
value ;  it  has  been  as  good  as  gold. 

§  5.  One  other  important  event  remains  to  be  noted,  the 
last  in  the  chain  of  those  which  deposed  silver  from  its  former 
monetary  place.  In  1893,  the  same  year  in  which  the  United 
States  ceased  its  purchases  of  silver  for  coinage  into  dollars, 
British  India  put  an  end  to  the  free  coinage  of  silver.  The 
flow  of  specie  to  the  East,  already  referred  to,1  had  always 
been  chiefly  in  the  form  of  silver.  British  India,  by  far  the 
most  important  country  of  the  East,  had  coined  that  silver 
freely  into  rupees  (whose  bullion  content  is  about  two  fifths 
that  of  the  United  States  dollar).  The  continued  fall  in  the 
price  of  silver  caused  serious  embarrassments,  of  which  more 
will  be  said  elsewhere.2  After  long  and  patient  waiting,  the 
British  government  in  India  finally  took  the  drastic  step  of 
closing  its  mints  to  silver.  Thus  in  one  year,  1893,  the  last 
two  great  markets  for  silver  —  the  United  States  and  British 

1  Chapter  18,  §  4. 

*  Chapter  23,  §  5 ;  Chapter  32,  §  6. 


THE  DISPLACEMENT  OF  SILVER 


285 


India  —  were  closed.  This  was  just  twenty  years  after  the 
France  mint  began  the  great  change. 

The  bottom  seemed  to  drop  out  of  silver  in  1893.  Its  pro- 
duction had  been  steadily  increasing  for  a  quarter  of  a  century. 
Before  1870  the  annual  supply  from  the  mines  had  been  about 
thirty  million  ounces.  After  1870,  it  rose  thus  :  — 

MILLION 
OUNCES 

Average  annual  product  in  the  5-year  period  1871-1875 63 

1876-1880 79 

1881-1885 92 

1886-1890 109 

1891-1895 158 

1896-1900 165 

1901-1905 168 

So  great  a  fresh  supply  pressing  on  the  market,  with  most 
mints  closed  to  free  coinage,  caused  a  steady  decline  in  price. 
In  terms  of  United  States  money,  the  ounce  of  silver  fell  from 
$1.29  in  1873  to  about  $.90  in  1892.  The  American  purchases 
under  the  acts  of  1878  and  1890  did  not  serve  to  prevent  that 
decline,  though  doubtless  they  made  it  less  abrupt.  With  the 
two  closures  of  1893  (in  the  United  States  and  British  India), 
the  price  fell  sharply  to  $.67.  In  1894  it  was  on  the  average 
about  $.64. 

Since  1893  silver  has  maintained,  on  the  whole,  the  levels 
reached  in  that  year  both  as  to  production  and  price.  The 
production  has  not  sensibly  diminished  or  sensibly  increased; 
the  price  has  been  in  the  neighborhood  of  $.60  an  ounce.  At 
that  price  the  market  ratio  is  about  34  to  1.  It  follows  that 
the  silver  dollar  contains  less  than  half  its  nominal  content; 
that  is,  as  metal  it  is  worth  less  than  fifty  cents  in  gold.  The 
French  five-franc  pieces  are  overvalued  to  a  similar  degree. 
Silver  has  become  in  all  the  leading  countries  a  commodity 
like  any  other,  fluctuating  in  price  according  to  market  condi- 
tions. It  is  bought  in  large  quantities  by  governments  for 
manufacture  into  subsidiary  coin,  and  the  demand  for  this 
purpose  has  proved  to  increase  steadily.  It  is  used  in  the  arts 
in  growing  quantities;  and  the  East  still  absorbs  considerable 


286   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

amounts,  partly  for  monetary  use,  partly  for  ornament,  partly 
for  hoarding.  That  its  production  continues  undiminished, 
notwithstanding  the  great  fall  in  price,  indicates  that  its 
marginal  cost  is  not  greater  than  the  price  that  has  ruled  during 
the  last  fifteen  years  (1893-1908). 

It  will  now  be  obvious  why,  as  was  stated  in  the  preceding 
chapter,  the  value  of  silver  is  related  to  its  expenses  of  pro- 
duction in  a  different  way  from  what  it  was  in  former  centuries? 
and  in  a  different  way  from  gold.  Silver  no  longer  has  a  free 
opening  in  monetary  use.  The  annual  supply  can  no  longer 
be  added,  as  can  that  of  gold,  to  a  vast  monetary  stock.  What 
part  shall  be  added  to  the  circulating  medium  in  the  form  of 
subsidiary  coin  depends  on  the  purchases  which  governments 
choose  to  make.  The  annual  supply  is  sold,  like  that  of  other 
metals,  at  whatever  price  it  will  fetch.  The  price  corresponds 
in  a  rough  way  to  its  marginal  cost,  and  is  in  a  rough  way 
determined  by  its  marginal  cost.  The  existing  silver  coins  of 
the  countries  of  the  limping  standard  are  kept  at  an  artificial 
value ;  but  this  artificial  value  has  no  influence  on  the  value 
of  the  newly  accruing  output  from  the  mines. 

§  6.  Two  entirely  different  questions  of  principle  arose  during 
the  course  of  the  deposition  of  silver.  One  concerned  the  rela- 
tive values  of  gold  and  silver,  and  the  effects  on  those  relative 
values  of  bimetallism  and  of  monometallism.  The  other  con- 
cerned the  general  range  of  prices  and  the  effects  on  prices  of 
bimetallism  and  monometallism.  The  bimetallists  contended 
that  their  system  conduced  to  a  more  stable  ratio  between  silver 
and  gold.  They  also  contended  that  it  conduced  to  a  greater 
stability  in  prices.  On  the  first  question  they  were  probably  in 
the  right ;  on  the  second  question  the  verdict  of  recent  history 
has  been  on  the  whole  against  them. 

We  have  seen,  in  the  case  of  France,  that  the  very  existence 
of  complete  bimetallism  —  free  coinage  of  both  metals  —  tends 
to  keep  the  value  of  the  two  metals  in  correspondence  with  the 
ratio.  Suppose  now  that  the  industrial  area  over  which  free  coin- 
age prevailed  had  been  very  much  larger  than  France.  Sup- 


THE  DISPLACEMENT  OF  SILVER  287 

pose  that  not  only  France  and  the  Latin  Union,  but  England, 
Germany,  the  United  States,  had  coined  silver  and  gold  freely 
at  the  French  ratio  of  15?  to  1.  From  this  vast  area  the  ex- 
pulsion of  gold  would  have  been  difficult,  nay,  well-nigh  impos- 
sible. The  countries  mentioned  include  all  those  in  which  gold 
is  freely  coined  on  a  great  scale,  or  at  least  all  those  in  which  gold 
was  so  coined  during  the  period  of  the  great  fall  in  silver. 
Whither  could  the  gold  have  been  driven  ?  The  ordinary  avenue 
of  departure — exportation — could  hardly  have  been  followed, 
since  there  were  no  important  countries  to  which  large  quan- 
tities of  gold  could  have  been  exported.  A  rapid  rise  in  general 
prices  would  perhaps  have  stimulated  a  markedly  increased  in- 
dustrial consumption ;  but  this  would  have  been  a  slow  process, 
coming  to  its  term  long  before  all  the  gold  had  been  absorbed  in 
the  arts.  A  rapid  rise  in  general  prices,  again,  might  conceivably 
have  checked  the  production  of  gold ;  but  this,  too,  would  have 
been  a  slow  and  uncertain  process,  having  its  term  like  the  other, 
—  at  the  point  where  the  poorer  mines  had  been  brought  to  a 
stop.  The  monetary  stock  of  gold  would  have  remained  in 
monetary  use  without  great  change,  and  would  perforce  have 
remained  in  circulation  side  by  side  with  silver.  This  result 
would  have  been  the  more  probable  because,  if  the  leading  coun- 
tries had  adopted  bimetallism  at  a  common  ratio,  the  lesser 
countries  would  have  been  likely  to  join  them.  International 
bimetallism,  applied  unflinchingly  by  the  leading  countries, 
would  have  brought  about  the  proximate  object,  —  the  con- 
current circulation  of  the  two  metals  as  money,  and  a  market 
value  corresponding  to  the  mint  ratio. 

This  conclusion  is  subject  to  possible  qualification.  It  rests 
on  the  assumption  that  people  in  general,  and  the  business  com- 
munity in  particular,  would  accede  to  the  regulations  contem- 
plated (and  in  part  prescribed)  by  governments.  Thus,  silver 
would  be  made  a  legal  tender  in  payment  of  debts,  and  therefore 
as  good  as  gold  for  a  vitally  important  monetary  use.  Con- 
ceivably, however,  general  opinion  —  general  prejudice,  if  one 
is  disposed  so  to  call  it  —  would  boycott  the  use  of  silver.  As 


288       MONEY  AND  THE   MECHANISM  OF  EXCHANGE 

«. 

will  be  seen  in  connection  with  the  history  of  paper  money,1  the 

power  of  government  in  forcing  the  use  of  a  particular  kind  of 
money  has  its  limits.  To  make  money  legal  tender  is  by  no 
means  necessarily  to  make  it  pass  in  general  circulation.  But 
in  the  special  case  here  supposed  for  silver,  it  is  not  probable  that 
a  government  would  have  overpassed  the  limits  within  which  it 
would  affect  the  use  of  money.  Silver  was  in  most  parts  of  the 
world,  in  the  period  from  1873  to  1893,  a  familiar  and  not  unwel- 
come form  of  money.  True,  in  Great  Britain  it  was  not  familiar, 
and  much  prejudice  in  that  country,  and  in  the  United  States 
and  Germany  also,  would  have  had  to  be  overcome;  yet  the 
obstacles  against  the  acceptance  of  the  new  situation  would 
hardly  have  been  insuperable. 

The  direct  obstacles  in  the  way  of  international  bimetallism 
were  political.  There  never  was  a  chance  for  the  conclusion  of  a 
compact.  Great  Britain  at  no  time  was  willing  to  accede, 
except  as  to  British  India,  which  would  not  have  brought  any 
new  strength  to  the  bimetallic  league.  Without  Great  Britain, 
Germany  would  not  come  in ;  without  at  least  one  of  those  coun- 
tries, the  United  States  would  not.  Whatever  the  abstract 
possibilities  of  united  bimetallism,  the  project  never  had  a 
working  prospect  of  realization. 

§  7.  Very  different  is  the  second  question  that  arose,  regard- 
ing the  stability,  not  of  the  ratio  between  the  metals,  but  of  the 
general  range  of  prices.  And  this,  obviously,  is  by  far  the  more 
important  question.  It  does  not  matter  much  to  the  com- 
munity (though  it  may  very  greatly  concern  the  mine  owners) 
whether  silver  exchanges  for  gold  at  the  rate  of  15  to  1  or  30  to  1. 
But  it  matters  very  much  whether  prices  go  up  or  go  down  or 
remain  stable.  That  they  should  remain  as  stable  as  possible 
is  the  desirable  situation.  How  far  would  international  bi- 
metallism have  promoted  this  result? 

The  answer  to  this  question  depends  on  the  extent  to  which 
the  total  supply  of  specie  —  gold  and  silver  —  would  have 
been  affected.  In  the  year  1890  the  answer  seemed  doubtful. 

1  See  below  in  this  book,  Chapter  23,  §  1. 


THE  DISPLACEMENT  OF  SILVER  289 

The  production  of  gold  then  seemed  virtually  stationary. 
That  of  silver,  on  the  other  hand,  was  rapidly  mounting,  in  face 
even  of  a  steady  fall  in  the  price  of  silver.  The  opponents  of 
bimetallism  maintained  that  silver,  once  restored  to  free  coinage, 
would  be  produced  in  immensely  greater  quantity.  Under 
modern  mining  methods,  vast  known  deposits  of  low-grade 
silver-bearing  ore  can  be  treated;  the  question  is  not  one  of 
discovery  or  speculation,  but  simply  of  calculable  profit.  Raise 
the  price  of  silver  to  $1.33  an  ounce  (the  price  in  United  States 
gold  corresponding  to  a  ratio  of  15^  to  1),  and  floods  of  silver  may 
be  expected  to  come  out.  Some  cool-headed  observers  predicted 
that  the  addition  to  the  monetary  stock  would  be  so  huge  as  to 
double  prices  in  ten  years.  The  bimetallists  on  the  other  hand 
said  that  the  increase  in  output  would  not  at  all  be  so  great,  and 
that,  with  a  stationary  or  declining  output  of  gold,  and  with  a 
great  area  over  which  the  total  stock  could  spread,  the  change 
in  prices  would  be  slow,  and  so  far  as  it  did  take  place  rather 
beneficial  than  otherwise. 

Whatever  doubt  there  may  have  been  regarding  the  probabili- 
ties of  the  case  —  and  there  was  much,  about  1890  —  was  set  at 
rest  by  the  new  conditions  governing  the  supply  of  gold  which 
set  in  after  that  date.  The  wonderful  increase  in  the  annual 
product  of  that  metal  has  already  been  described.  The  danger 
of  a  scant  supply  of  gold  —  so  scant  as  to  keep  prices  moving 
downward  —  disappeared.  If  silver  had  been  freely  coinable 
as  well  as  gold,  the  total  supply  of  the  two  metals  would  have  in- 
creased without  fail  at  a  portentous  rate.  Even  at  the  low  prices 
of  silver  which  have  prevailed  since  1893,  the  production  of  that 
metal  has  not  diminished;  it  has  remained  stationary.  At 
doubled  prices,  it  would  surely  have  increased  rapidly,  and  so 
have  added  much  more  to  the  supply  of  specie.  Bimetallism 
would  have  led  not  to  stable  prices,  but  to  prices  even  less  stable, 
and  advancing  even  more  rapidly,  than  under  the  single  gold 
standard.  The  extraordinary  increase  in  the  production  of  gold 
has  put  an  end,  probably  forever,  certainly  for  an  indefinite 
period,  to  all  proposals  for  rehabilitating  silver. 


CHAPTER  22 

CHANGES  IN  PRICES 

§  1.  Two  topics  will  be  taken  up  in  the  present  chapter: 
first,  how  to  ascertain  and  measure  whether  changes  in  prices 
have  taken  place ;  second,  what  are  the  consequences  for  good 
or  ill  of  such  changes.  Of  the  causes  of  the  changes  nothing 
more  will  be  said  for  the  present. 

The  measurement  of  changes  in  the  value  of  money  would  be 
easy  if  all  prices  went  up  and  down  together.  But  this  they 
never  do.  Some  prices  go  up,  while  others  go  down.  Occa- 
sionally in  times  of  very  great  and  rapid  movement,  all  prices 
change  in  the  same  direction.  Even  then,  they  do  not  all  change 
to  the  same  extent ;  some  rise  or  fall  in  less  degree  than  others ; 
hence,  though  the  fact  of  a  change  in  a  given  direction  may 
be  clear,  the  extent  of  the  change  becomes  difficult  to  meas- 
ure. 

To  get  a  summary  expression  of  the  general  trend  of  prices, 
resort  is  had  to  the  method  of  index  numbers.  An  example  will 
best  explain  how  an  index  number  is  constructed.  Suppose  that 
on  January  1, 1900,  the  price  of  iron  was  $15  a  ton,  of  wheat  $1 
a  bushel,  of  cotton  10  cents  a  pound,  of  wool  40  cents  a  pound. 
These  are  called  the  base  prices.  Later  prices  are  expressed  in 
relation  to  them,  usually  by  stating  them  in  terms  of  a  percentage. 
Suppose  that  a  year  later,  on  January  1,  1901,  the  prices  of 
these  four  commodities  have  come  to  be  $20  for  iron,  $1.25  for 
wheat,  10  cents  for  cotton,  36  cents  for  wool.  Then  the  actual 
prices,  and  the  percentage  relation  between  them,  would  stand 
thus:  — 


290 


CHANGES  IN  PRICES 


291 


190 

0 

i< 

)01 

BASE  PRICE 

100 

PRICE 

PERCENTAGE 
TO  BABE 

$15.00 

100 

$20.00 

133 

Wheat  

1.00 

100 

1.25 

125 

Cotton      .... 

.10 

100 

.10 

100 

Wool    

.40 

100 

.36 

90 

Total       .... 

400 

448 

Average  (arithmeti- 

cal mean) 

100 

112 

The  index  number  was  400  for  1900,  and  rose  to  448  for  1901. 
Reduced  to  the  arithmetic  mean,  the  index  number  for  1900  was 
100;  that  for  1901  became  112.  Sometimes  index  numbers  are 
given  in  the  first  form  by  simple  summation ;  such,  for  example, 
is  the  mode  in  which  the  well-known  index  number  of  the  Lon- 
don Economist  is  made  up.  More  often  the  numbers  are  aver- 
aged. The  base  average,  of  course,  is  always  100 ;  the  average 
for  any  other  year  is  then  a  percentage  of  the  base  average. 
In  the  example  just  given,  the  index  number  shows  a  rise  in 
prices  of  twelve  per  cent ;  or,  rather,  as  the  very  word  "  index  " 
implies,  indicates  a  rise  to  that  extent. 

If,  now,  instead  of  four  commodities,  fifty  or  a  hundred  were 
treated  in  this  way,  we  should  feel  some  confidence  in  the  indica- 
tion obtained  as  to  a  general  change  in  prices.  If  the  sum- 
marized result  as  to  a  large  number  of  articles  is  an  advance  of 
ten  or  twenty  per  cent  in  the  index  number,  it  is  tolerably  certain 
that  most  commodities  have  gone  up  in  price.  No  doubt  it  is 
possible  that  the  result  has  been  due  to  the  fact  that  half  the 
commodities  went  up  a  great  deal,  and  that  the  other  half  went 
down,  though  but  moderately.  But  an  examination  of  actual 
changes,  even  a  cursory  one,  almost  always  shows,  where  a 
marked  change  has  occurred  in  an  index  number,  that  the  large 
majority  of  prices  have  moved  in  the  one  way  indicated.  The 
index  number  serves,  therefore,  to  point  to  a  fact,  —  that  on  the 
whole  prices  have  gone  up. 

§  2.   Other  modes  of  reaching  index  numbers  are  proposed,  the 


arithmetical  mean  being  criticized  as  crude  and  inadequate. 
Some  of  the  suggested  improvements  may  be  briefly  noted,  and 
the  usefulness  of  the  simpler  method  tested  by  comparison  with 
the  results  from  those  more  complex. 

The  geometrical  mean  has  been  advocated;  and  sometimes 
other  mathematical  means.  Of  the  geometric  mean  it  is  said, 
with  undoubted  truth,  that  its  use  will  mitigate  a  misleading 
effect  on,  the  index  number  from  extraordinary  fluctuations  in 
the  price  of  a  single  article.  With  the  use  of  logarithms  the 
geometric  mean  is  easy  to  ascertain ;  and  it  has  quite  as  good  a 
right  to  be  entitled  a  "true"  average  as  the  arithmetic. 

Another  proposal  is  for  the  use  of  the  median.  Let  the  index 
numbers  be  made  up,  not  by  averaging,  but  by  ascertaining  mid- 
way points.  Arrange  the  several  price  quotations  for  any  year 
(reduced  to  a  uniform  basis  as  for  the  other  methods)  in  nu- 
merical order,  and  then  ascertain  that  figure  which  stands  in  the 
middle  of  the  series,  —  that  figure  on  either  side  of  which  there 
are  an  equal  number  of  quotations.  For  various  sorts  of  obser- 
vations the  median  is  thought  by  statisticians  to  be  at  least  as 
significant  as  any  average;  and  though  comparatively  un- 
familiar, it  is  easy  to  use.  Even  more  than  the  geometric 
mean,  it  prevents  an  extremely  high  or  low  price  of  some  one 
article,  or  of  a  very  few  articles,  from  having  an  undue  influence 
on  the  index  number.1 

Entirely  different  is  the  improvement  of  the  simpler  method 

1  Thus  if  a  series  of  price  quotations,  reduced  to  a  basis  of  100,  were 
86  102 

90  106 

94  110 

97  120 

100 

the  median  would  be  100.  If  the  last  figure  were  not  120,  but  150,  the  median 
would  still  be  100. 

There  being  in  this  series  an  odd  number  of  figures,  the  median  is  the  middle 
one.  If  there  were  an  even  number,  the  median  would  lie  between  the  two 
middle  figures,  and  would  be  in  so  far  indefinite.  But  where  there  are  many 
figures,  as  is  always  the  case  with  price  quotations,  the  median  is  sufficiently 
precise. 

For  an  illustration  of  divergence  between  the  median  and  the  arithmetic 
mean,  see  Chapter  23,  p.  318. 


CHANGES  IN  PRICES 


293 


itself  —  the  arithmetic  mean  —  by  taking  account  of  the  rela- 
tive importance  of  the  different  articles ;  or,  as  it  is  technically 
put,  by  weighting  the  articles.  A  change  in  the  price  of  wheat, 
for  example,  is  of  much  more  importance  than  a  change  in  the 
price  of  wool.  If  wheat  were  to  double  in  price,  the  purchasing 
power  of  a  given  income  would  be  seriously  affected ;  if  wool 
were  to  double  in  price,  much  less.  The  varying  importance  of 
different  commodities  may  be  regarded  in  the  construction  of 
an  index  number  by  assigning  weight  to  the  commodities  in  the 
proportion  of  their  consumption.  If  the  community  as  a  whole 
spends  four  times  as  much  of  its  income  on  wheat  as  on  wool, 
wheat  may  be  counted  as  if  it  were  four  articles  and  wool  as  if 
it  were  one.  If  twice  as  much  is  spent  on  cotton  as  on  wool, 
cotton  may  be  counted  as  if  it  were  two  articles ;  while  iron, 
on  similar  assumptions,  may  be  counted  as  three.  The  prices 
just  used  for  illustration  would  then  be  made  up  into  an 
index  number  as  follows  :  — 


1900 

1901 

WEIGHT 

BASE 
PRICE 

WEIGHTED 
BASH 

PRICE 

PERCENTAGE 
OP  CHANGE 
IN  PRICE 

WEIGHTED 
CHANGE  IN 
PRICE 

Wheat  .     . 

4 

$1.00 

400 

$1.25 

125 

500 

Cotton. 

2 

.10 

200 

.10 

100 

200 

Wool    .     . 

1 

.40 

100 

.36 

90 

90 

Iron.     .     . 
Total      . 

3 
10 

15.00 

300 

20.00 

133| 

400 

1000 

1190 

Average 

100 

119 

This  weighted  average  indicates  a  rise  in  prices  from  100  to  119, 
whereas  the  simple  average  indicated  one  from  100  to  112  only. 
And  the  weighted  average  is  plainly  the  more  significant ;  since 
the  higher  prices  of  widely  used  articles  like  wheat  and  iron 
are  more  important  than  the  lower  price  of  the  less  used  wool. 

Though  the  weighted  index  number  is  clearly  preferable,  the 
application  of  this  more  refined  method  presents  difficulties.  It 
is  not  easy  to  ascertain  the  consumption  or  relative  weight  of  the 
several  articles,  especially  where  a  very  large  number  (100  or 


294   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

more  perhaps)  are  included  in  the  list.  Moreover,  the  consump- 
tion of  the  different  articles  varies.  Changes  in  habits  take 
place ;  one  article  may  be  much  less  used  in  1910  than  in  1900 ; 
how  readjust  its  weighting  and  the  whole  weighted  index  num- 
ber? These  difficulties,  and  others  that  might  be  instanced, 
though  not  insuperable,  add  to  the  complications  of  weighting. 

In  regard  to  all  these  suggestions,  whether  for  improvement  in 
the  arithmetic  mean  or  for  the  use  of  a  different  mean,  it  must 
be  borne  in  mind  that  no  index  number  corresponds  to  a  real 
thing.  It  is  not  like  the  mean  of  certain  observations  in  natural 
science  —  such,  for  example,  as  those  for  measuring  the  distance 
between  the  earth  and  the  sun  —  of  which  any  one  may  err, 
but  whose  average  will  point  to  a  single  specific  fact.  An  index 
number  points  to  no  single  fact.  It  gives,  to  repeat,  only  an 
indication  of  the  general  trend  of  prices.  People  often  speak 
and  think  loosely  on  this  topic,  as  if  an  index  number  told  the 
whole  story  once  for  all.  There  is  no  one  change  in  prices. 
There  is  a  medley  of  many  changes,  different  in  direction  and 
degree.  All  that  we  can  hope  to  secure  by  averaging  and  sum- 
marizing is  some  concise  statement  of  the  general  drift. 

Now  experience  in  the  application  of  the  various  methods  to 
the  same  sets  of  figures  shows  that  the  simple  arithmetic  mean, 
when  applied  to  a  sufficiently  large  number  of  price  quotations, 
gives  substantially  the  same  results  as  more  refined  methods.  If 
many  articles  are  in  the  list,  some  of  much  importance,  some  of 
little,  it  is  unlikely  that  all  the  important  articles  will  fluctuate  in 
one  direction  and  all  the  unimportant  in  another.  If  they  did  so 
(as  in  the  example  just  given),  weighting  would  be  indispensable. 
But  the  fluctuations  in  fact  are  likely  to  be  distributed  among 
the  several  classes  in  much  the  same  way.  An  unusual  change 
in  the  price  of  a  particular  article,  whether  it  be  consumed  in 
large  amounts  or  in  small,  will  not  affect  greatly  an  average 
made  up  from  many  price  quotations.  And  in  practise  it  has 
been  found  that  the  simple  unweighted  average  brings  results  not 
very  different  from  those  obtained  after  weighting.  Similarly, 
it  has  been  found  that  the  method  of  the  median  does  not  yield, 


CHANGES  IN  PRICES 


295 


for  such  fluctuations  in  prices  as  take  place  under  a  specie 
standard,1  results  substantially  different  from  those  of  either 
the  simpler  or  the  weighted  arithmetical  mean. 

This  similarity  of  outcome  is  illustrated  by  the  following  chart, 
showing  the  course  of  four  index  numbers  reached  in  different 
ways,  all  based  on  the  same  quotations  of  prices.2  One  repre- 
sents the  simple  arithmetic  mean  of  250  price  quotations ;  the 
second,  another  arithmetic  mean  of  the  same  prices  consoli- 

1  Compare  what  is  said  below,  Chapter  23,  p.  318. 
*  The  four  series  are  :  — 

(1)  The  Department  of  Labor's  arithmetic  means,  for  prices  of  250  articles. 

(2)  Professor  W.   C.  Mitchell's  rearrangement  of  the  same  price  figures : 
"The  Bureau's  list  of  commodities  contains  anomalies  such  as  the  inclusion  of  a 
single  series  [of  quotations]  for  wheat  and  ten  for  cotton  sheetings ;  two  for  hogs 
and  three  for  glassware,  etc.     The  result  is  most  unscientific  weighting  in  what 
purports  to  be  an  unweighted  index  number.     To  remedy  this  obvious  defect, 
I  have  combined  the  series  for  nearly  identical  articles,  thereby  reducing  the 
number  of  series  to  145."  —  Journal  of  Political  Economy,  May,  1910,  p.  372 ; 
cp.  the  same  writer's  Gold,  Prices,  and  Wages  under  the  Greenback  Standard,  p.  19. 

(3)  The  median  for  the  same  (145)  series  of  quotations,  as  calculated   by 
Professor  Mitchell. 

(4)  A  weighted  index  number  for  50  staple  articles,  selected  from  among  the 
250  (145) ;  the  weighting  being  on  the  plan  of  the  Gibson  index,  but  revised  by 
Professor  Mitchell. 

The  figures  of  the  four  series  are :  — 


I 

ARITHMETIC  MEAN 
op  250  QUOTA- 
TIONS 

II 

ARITHMETIC  MEAN 
OF  145  QUOTA- 
TIONS 

III 

MEDIAN  OF  145 
QUOTATIONS 

IV 
WEIGHTED  INDEX 
NUMBERS  PROM 
50  QUOTATIONS 

1890 

112.9 

114.1 

112 

114.0 

1891 

111.7 

112.7 

111 

113.9 

1892 

106.1 

106.1 

107 

105.1 

1893 

105.6 

105.0 

104 

105.2 

1894 

96.1 

95.6 

96 

93.9 

1895 

93.6 

92.8 

94 

93.9 

1896 

90.4 

88.8 

90 

86.6 

1897 

89.7 

88.7 

91 

89.2 

1898 

93.4 

93.5 

94 

95.0 

1899 

101.7 

102.5 

100 

103.4 

1900 

110.5 

111.3 

109 

111.6 

1901 

108.5 

109.6 

107 

109.2 

1902 

112.9 

113.7 

110 

116.2 

1903 

113.6 

113.8 

111 

115.3 

1904 

113.0 

113.9 

112 

116.3 

1905 

115.9 

115.8 

114 

\         117.9 

1906 

122.5 

122.3 

119 

123.4 

296   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 


dated  into  145  quotations;  the  third,  the  median  of  these 
same  145  quotations ;  the  fourth,  a  weighted  index  number  of 
50  among  these  commodities.  The  prices  are  at  wholesale,  in 


LJJ     UJ 

5    2 
O   O 


5   2 

X   X 
I-   H 


the  United  States,  for  the  period  1890-1906;  the  "base,"  indi- 
cated by  100,  is  in  each  case  the  average  (arithmetic  mean)  for 
the  decade  1890-1899. 


CHANGES  IN  PRICES  297 

§  3.  A  rise  in  prices  is  of  advantage  to  debtors ;  a  fall  in 
prices  is  of  advantage  to  creditors.  When  prices  go  up  in  the 
interval  between  the  contracting  and  the  paying  of  a  debt, 
the  debtor,  on  returning  to  his  creditor  the  amount  of  money 
borrowed,  returns  less  in  the  way  of  commodities.  Conversely, 
when  prices  go  down  in  the  interval,  the  debtor,  on  returning 
the  same  money,  returns  more  in  the  way  of  commodities. 

Most  changes  in  prices  are  slow;  from  year  to  year  there  is 
little  variation.  Most  debts,  on  the  other  hand,  are  for  short 
periods  of  time.  Hence  fluctuations  in  general  prices  do  not 
ordinarily  cause  injustice  or  serious  embarrassment.  Even  over 
a  period  of  several  years  the  dealings  between  debtor  and  cred- 
itor are  usually  carried  on  with  sufficient  equity.  An  index 
number  change  of  five  per  cent  in  a  single  year  is  unusual. 
Commonly  our  observations  must  extend  over  two  or  three  years 
if  we  are  to  make  sure  that  any  general  rise  or  fall  is  really  in 
progress.  A  change  of  five  per  cent  or  ten  per  cent,  as  registered 
in  an  index  number,  would  probably  be  little  noticed  by  most 
debtors  and  creditors.  Each  would  be  concerned  only  with  the 
particular  articles  bought  or  sold  by  him ;  and  these  articles  might 
remain  unchanged  in  price,  or  move  in  a  different  direction  from 
the  index  numbers,  or  in  different  degree.  It  is  only  abrupt 
and  marked  changes  in  prices  that  disturb  the  usual  approxi- 
mate equity  of  debt  payments.  Under  a  specie  standard,  such 
changes  do  not  take  place ;  this  much  is  brought  about  by  the 
durability  of  specie  and  the  consequent  slowness  of  changes  in 
the  total  stock.  Violent  changes,  over  short  periods  of  time, 
take  place,  if  at  all,  from  resort  to  irredeemable  paper  money. 
There  is  a  sound  basis  for  the  attitude  which  most  people  take, 
of  regarding  specie  as  stable  in  value  and  measuring  incomes, 
possessions,  debts  and  credits,  once  for  all  in  terms  of  money. 

The  case  is  different  with  debts  having  a  long  time  to  run. 
As  to  these,  even  under  a  specie  regime,  there  is  a  considerable 
possibility  of  injustice  and  hardship.  In  the  course  of  twenty 
years,  possibly  in  the  course  of  ten,  marked  changes  in  general 
prices  may  occur,  and  with  them  marked  injustice  to  debtors  or  to 


298   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

creditors,  as  the  case  may  be.  Though  obligations  running  over 
such  a  long  period  are  not  often  contracted  by  individuals,  they 
are  not  uncommon  on  the  part  of  corporations  and  of  govern- 
ments. European  governments,  to  be  sure,  when  they  borrow, 
usually  do  not  undertake  to  repay  the  principal  sum  at  any  given 
date ;  they  promise  only  the  regular  payment  of  a  stipulated  rate 
of  interest.  They  reserve  the  option  of  repaying  the  principal 
(either  at  times  expressly  stated  or  at  their  discretion),  but  they 
need  not  repay  unless  it  suits  them.  In  such  case  they  have  a 
protection  against  loss  from  price  changes,  though  their  creditors 
have  none.  The  United  States  government  has  often  borrowed 
on  long  time,  and  exposed  itself  to  possible  loss ;  a  practise,  how- 
ever, which  has  been  kept  in  recent  years  within  such  moderate 
limits  as  not  to  forebode  substantial  difficulties.  Many  of  our 
great  corporations,  however,  and  especially  the  railway  corpora- 
tions, have  borrowed  quite  without  regard  to  possible  price 
changes,  and  indeed  also  with  disregard  of  possible  changes  in  the 
rate  of  interest.  Bonds  have  been  issued  payable  after  the  lapse 
of  twenty,  forty,  even  one  hundred,  years,  without  provision  for 
redemption  in  the  interval.  Who  can  say  what  will  be  the 
range  of  prices  after  the  lapse  of  decades  or  of  a  century  ? 

Such  long-time  obligations  find  a  market  because  most  invest- 
ors (like  other  people)  think  of  the  value  of  money  as  unchanging, 
and  because  they  are  glad  to  have  an  income,  supposed  to  be 
fixed,  guaranteed  for  a  long  time.  Corporations,  on  the  other 
hand,  when  they  wish  to  raise  great  sums  of  money,  adopt  the 
devices  which  will  entice  the  investor.  Yet  in  such  engagements 
both  debtors  and  creditors  take  great  and  unpredictable  risks. 
Under  monetary  systems  as  they  now  are,  and  are  likely  long  to 
remain,  these  risks  can  be  avoided  only  by  restricting  all  loans 
to  periods  of  a  moderate  number  of  years. 

§  4.  A  different  question  as  to  justice  between  debtor  and 
creditor  arises  from  the  fact  that  money  wages  and  other  money 
incomes  do  not  necessarily  move  in  the  same  way  as  the  prices  of 
commodities.  In  the  preceding  sections,  it  has  been  tacitly 
assumed  that  these  two  movements  —  of  prices  and  of  money 


CHANGES  IN  PRICES  299 

incomes — proceed  pan  passu.  But  they  do  not  always  do  so. 
One  may  lag  behind  the  other;  or  the  movements  may  be  in 
opposite  directions. 

Suppose,  for  example,  —  to  take  the  sort  of  case  which,  for- 
tunately, is  most  probable,  —  that  industry  is  progressing,  the 
arts  are  advancing,  the  prosperity  of  the  community  growing. 
This  means  that  real  incomes  are  becoming  larger ;  that  the  com- 
modities and  utilities  at  the  command  of  the  community  as  a 
whole,  and  on  the  average  for  each  person,  are  more  abundant. 
The  concrete  way  in  which  that  abundance  must  show  itself, 
where  all  transactions  and  all  exchanges  are  carried  on  through 
money,  is  in  cheapness  of  goods  relatively  to  incomes.  Goods 
may  become  cheaper,  money  incomes  remaining  the  same ;  or 
money  incomes  may  become  greater,  prices  remaining  the  same ; 
or  some  intermediate  relation  may  appear.  In  any  case,  prices 
and  incomes  will  not  move  together.  Relatively  to  prices,  money 
incomes  will  rise. 

Thus,  during  the  period  of  falling  prices  after  1873,  money  in- 
come on  the  whole  did  not  fall.  The  evidence  to  prove  this 
relates  chiefly  to  the  familiar  crafts  and  to  unskilled  or  little 
skilled  labor;  since  comparison  of  wages  at  different  times  is 
here  easiest.  Money  wages  on  the  whole  did  not  fall  after  1873 ; 
they  rather  tended  to  rise.  So  it  was  as  to  those  rates  of  wages 
which  are  euphemistically  called  salaries, — the  pay  of  teachers, 
corporation  employees,  public  officials.  The  same  upward  tend- 
ency, or,  at  the  least,  stationary  tendency,  showed  itself  in  the 
more  irregular  money  incomes  of  professional  and  business  men. 
With  rising  or  stationary  wages  and  incomes,  and  with  falling 
prices,  real  incomes,  in  term  of  commodities  and  of  utilities, 
must  have  gone  up  substantially.  Obviously,  this  was  the  nat- 
ural outcome  of  industrial  progress  and  cheapened  production. 
That  same  outcome  of  progress  and  cheapness,  however,  must  be 
expected  to  appear  in  a  period  of  rising  prices ;  only  in  this  case 
in  a  different  way.  If  prices  advance,  money  incomes  must 
advance  at  least  as  much,  if  real  income  is  to  remain  the  same. 
If  the  same  fundamental  forces  are  at  work  to  promote  progress 


300   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

and  relative  cheapness,  wages  and  all  money  incomes  must  ad- 
vance even  more  than  prices.  If  the  increasing  gold  supply  of 
the  last  ten  years  proves  in  fact  to  bring  about  continuously  ris- 
ing prices,  we  must  expect  that  this  change  will  be  accompanied 
by  an  even  greater  rise  in  money  incomes.1 

What,  under  such  circumstances,  are  the  relations  between 
debtors  and  creditors?  With  prices  falling  and  incomes  sta- 
tionary, debtors,  paying  their  debts  with  the  same  amount  of 
money,  repay  to  creditors  more  in  the  way  of  commodities. 
This  may  be  called  repayment  according  to  a  labor  standard. 
It  is  true  that  the  debtor  pays  back  more  commodities  than  he 
got ;  but  those  commodities  represent  the  same  money  income 
and  (presumably)  the  same  amount  of  labor  as  before.  It  may 
be  fairly  argued  that  the  debtor  suffers  no  injustice,  if  at  the 
time  of  repayment  he  has  the  same  money  income  as  when  he 
contracted  the  debt.  The  creditor  simply  shares  in  the  greater 
cheapness  of  commodities  due  to  improved  production.  Suppose, 
on  the  other  hand,  that  there  are  stationary  prices  and  rising 
incomes.  The  debtor,  paying  back  the  same  money,  pays  back 
also  the  same  commodities.  It  may  again  be  fairly  argued  that 
the  creditor  suffers  no  injustice.  He  gets  back  precisely  what 
he  lent,  in  terms  both  of  money  and  of  goods.  He  can  be  said 
to  suffer  hardship  only  in  that  he  fails  to  share  the  full  advantage 
of  progress.  He  does  not  experience,  as  others  do,  rising  receipts 
with  stationary  expenses.  The  results  in  the  two  cases  are  dif- 
ferent ;  yet  in  each  it  may  be  plausibly  argued  that  the  out- 
come is  just,  or  at  least  not  unjust. 

It  is  fortunate  that  this  intricate  question  of  justice  does  not 
present  itself  in  such  a  way  as  to  involve  the  likelihood  of  any 
serious  departure  from  the  familiar  and  accepted  principles  of 
equity  in  debt  payments.  Just  as  movements  in  general  prices 

1  Long-run  effects  are  here  had  in  mind,  and  especially  those  long-run  effects 
which  are  to  be  expected  from  steady  gains  in  the  efficiency  of  industry.  The 
proximate  effect  of  increasing  gold  supply  is,  as  pointed  out  in  the  next  section, 
to  cause  prices  to  rise  faster  than  the  wages  of  hired  laborers  (though  not  faster 
than  all  money  incomes) .  It  is  only  in  the  long  run  that  this  effect  is  counter- 
acted by  that  of  continued  improvement  in  the  art*. 


CHANGES  IN  PRICES  301 

proceed  slowly,  and  therefore  do  not  entail  serious  injustice  as  re- 
gards most  debts,  so  the  relative  changes  of  prices,  money,  and 
money  incomes  proceed  slowly.  Thus  the  inverse  movement  of 
wages  and  prices  between  1873  and  1896,  referred  to  a  moment  ago, 
could  be  noticed  only  after  careful  observation  of  five-year  and 
ten-year  periods.  Again,  if  it  proves  true  —  as  there  is  reason  to 
expect  it  will  in  the  long  run  —  that  rising  prices  during  the  next 
generation  will  be  accompanied  by  money  incomes  rising  still  more, 
this  change  also  will  come  slowly  and  gradually,  as  the  ultimate 
result  of  the  irregular  march  of  improvements  in  production. 

If  it  be  asked,  none  the  less,  which  of  these  two  situations  — 
stationary  incomes  with  falling  prices,  or  rising  incomes  with 
stationary  prices  —  brings  the  more  equitable  adjustment  of 
the  relations  between  debtor  and  creditor,  the  answer  can- 
not be  given  with  ready  assurance.  The  problem  involves  a 
consideration  of  the  whole  problem  of  the  right  distribution  of 
wealth,  and  more  particularly  the  question  whether  equal  return 
for  equal  labor  is  the  right  basis  for  dealings  between  man  and 
man.1  In  this  case,  as  in  most  others,  we  must  be  content 
if  the  outcome  is  satisfactory  on  the  whole;  if  clear  injustice  is 
avoided,  even  though  that  which  is  ideally  just  be  not  attained. 
The  monetary  use  of  the  precious  metals  brings  advantages 
which  outweigh  its  disadvantages.  Specie  in  the  main  has 
brought,  and  still  brings,  stability  of  prices.  It  is  an  invaluable 
safeguard  against  crude  experimenting  and  arbitrary  change. 
The  system  of  private  property  and  free  exchange  works  better 
under  a  specie  standard  than  it  seems  likely  to  work  under  any 
other  medium  of  exchange  yet  discovered.  Though  the  standard 
inures  sometimes  to  the  advantage  of  debtors,  sometimes  to  that 
of  creditors,  and  though  sometimes  it  brings  complex  conditions 
under  which  very  difficult  questions  of  equity  arise, — none  the 
less,  we  must  be  satisfied  if  it  brings  on  the  whole  a  satisfactory 
working  arrangement.  No  part  of  the  existing  organization 
of  society  rests  more  frankly  on  a  utilitarian  basis  than  the  use 
of  specie  as  the  medium  of  exchange. 

1  See  Book  VII,  Chapter  64,  §  3. 


302   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

§  5.  The  proposal  for  a  multiple  standard  as  a  means  of 
remedying  the  effects  of  falling  and  rising  prices  on  debtors  and 
creditors  is  to  be  judged  by  this  same  utilitarian  standard. 
Briefly,  the  proposal  is  as  follows.  Let  there  be  kept  accurate 
records  of  the  prices  of  a  great  number  of  commodities,  and  let 
the  index  numbers  show  at  stated  periods  how  the  general  level 
has  changed.  Let  debtors  then  repay  creditors  in  such  way  that 
the  same  quantity  of  commodities  be  returned  the  creditors. 
Thus,  if  the  general  index  number  rises  from  100  to  110,  let  the 
debtor  who  has  borrowed  $100  pay  back  $110 ;  for  only  by,  the 
repayment  of  this  larger  sum  does  the  creditor  get  as  much  in 
the  way  of  commodities  as  he  gave.  Conversely,  if  the  index 
number  falls  from  100  to  90,  let  the  debtor  pay  back  $90  for 
every  $100  that  he  borrowed. 

To  any  such  scheme  there  are  various  objections.  The  un- 
certainty as  to  the  best  way  of  computing  index  numbers,  the 
varying  results  reached  by  different  methods  of  equal  validity, 
the  difficulty  of  recording  with  certainty  the  actual  changes  in 
prices,  the  inevitable  margin  of  error, — here  is  one  set  of  objec- 
tions. Another  arises  from  the  possibility,  just  discussed,  that 
money  incomes  may  change  in  a  different  direction  from  com- 
modity prices ;  though  this  is  commonly  evaded,  in  discussions  of 
the  multiple  standard,  by  the  tacit  assumption  that  a  quid  pro 
quo  in  terms  of  commodities  is  necessarily  just.  The  conclusive 
objection,  however,  is  that  under  the  multiple  standard  certainty 
and  calculability  would  cease  to  exist  in  all  transactions  involv- 
ing postponed  payments.  No  man  would  know,  when  con- 
tracting a  debt,  what  he  would  be  called  on  to  repay  when  it 
became  due.  He  would  have  to  watch  each  monthly  or 
quarterly  report  of  the  index-number  bureau,  and  guess  in  the 
meanwhile  how  his  affairs  would  have  to  be  adjusted.  It  is  true 
that,  as  things  now  are,  changes  in  the  prices  of  the  particular 
things  which  each  person  buys  and  sells  cause  uncertainty. 
But  every  one  in  business  necessarily  watches  these  changes  and 
adapts  his  doings  from  day  to  day  to  the  shifting  conditions ; 
:ndeed,  so  to  watch  them,  is  a  main  part  of  business.  To  add 


CHANGES  IN  PRICES  303 

to  this  inevitable  cause  of  uncertainty  another  from  unpredict- 
able changes  in  index  numbers  would  make  all  industrial  opera- 
tions irregular  and  halting.  If  the  scheme  were  put  into  effect, 
people  would  rebel  against  it  at  the  first  trial.  Or,  if  it  were  ar- 
bitrarily maintained,  the  speculative  element  in  all  transactions 
would  become  more  marked,  risks  would  be  greater,  the  mar- 
gin of  gain  for  middlemen  would  become  wider,  the  action  of 
competition  less  smooth  and  less  effective.  The  business  classes 
in  the  end  would  recoup  themselves  from  the  rest  of  the  com- 
munity for  the  trouble  and  risk  imposed.  The  plan  has  been 
rightly  called  one  for  a  "fancy"  monetary  standard.  Whether 
from  the  point  of  view  of  difficulty  in  administration  or  of  the 
outcome  under  the  best  conceivable  administration,  it  must  be 
rejected  on  any  sober  consideration. 

§  6.  It  might  seem  that,  barring  the  effects  on  debtors  and 
creditors,  rising  or  falling  prices  are  not  of  consequence.  It  is 
certainly  of  no  consequence  whether  a  community  reaches 
finally  a  stage  of  high  prices  or  of  low  prices.  The  only  differ- 
ence in  the  end  is  whether  many  counters  or  few  shall  be  used  in 
exchanges.  But  the  process  of  reaching  the  end  may  bring 
results  of  its  own.  It  is  maintained  by  many  that  the  tran- 
sition to  higher  prices  brings  good  results,  the  transition  to  lower 
prices  bad  results. 

Periods  of  rising  prices  are,  in  fact,  commonly  periods  of  pros- 
perity. In  part,  to  be  sure,  that  prosperity  is  rather  apparent 
than  real.  People  so  habitually  reckon  their  incomes  and  re- 
sources in  terms  of  money  that  they  think  themselves  better 
off  when  money  incomes  go  up.  They  disregard,  in  some  degree 
at  least,  the  fact  that  their  expenses  go  up  also.  But  it  is  not 
merely  a  matter  of  deceptive  appearances.  The  business  class 
feels  a  stimulus  from  rising  prices ;  and  so  long  as  the  manage- 
ment of  industry  is  in  the  hands  of  the  business  class,  that 
which  stimulates  its  members  to  activity  commonly  acts  as  a 
real  stimulus  to  productive  industry.  In  part,  no  doubt,  the 
effect  on  business  men,  as  on  others,  is  psychological.  They 
think  they  are  gaining  when  prices  rise,  whether  in  fact  they  do 


304       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

or  do  not  gain  as  regards  the  purchasing  power  of  their  incomes ; 
and  this  appearance  of  gain  spurs  them  to  activity.  But  they 
secure  also  real  and  substantial  advantages. 

These  advantages  do  not  arise  chiefly  from  the  fact  that  busi- 
ness men  are  debtors.  They  are  both  debtors  and  creditors.  It 
is  true  that  in  relation  to  the  investors,  they  are  debtors.  But 
the  men  of  large  affairs  —  the  wholesale  merchants,  the  manu- 
facturers, the  bankers  —  are  creditors  quite  as  much  as  debtors, 
in  relation  to  the  rest  of  the  community ;  and  it  is  the  large- 
scale  men  who  give  the  tone  and  temper  to  the  business  class. 

The  chief  explanation  of  the  optimism  and  activity  which 
business  men  as  a  class  show  in  times  of  rising  prices  arises 
from  the  relation  which  they  as  a  class  hold  to  the  laborers  as 
a  class.  At  bottom  their  main  operation  is  to  hire  laborers ; 
and  they  hire  laborers  to  advantage  at  such  times,  because  the 
prices  of  commodities  go  up  faster  than  money  wages. 

That  wages  go  up  more  slowly  than  prices  is  one  of  the  best- 
attested  facts  in  economic  history.  It  holds  good  of  almost 
all  sorts  of  hired  persons,  —  not  only  manual  laborers,  but 
clerks,  overseers,  teachers,  salaried  officials.  It  is  due  mainly 
to  the  force  of  custom,  which  is  especially  strong  as  to  wages ; 
and  it  is  strengthened  often  by  the  lack  of  bargaining  power 
among  laborers.  It  is  connected  with  many  peculiarities  in 
the  dealings  between  employers  and  employees,  and  especially 
with  the  position  of  the  employer  as  feeling  the  brunt  of  any 
industrial  change.  Of  the  fact  there  can  be  no  question; 
when  prices  rise,  the  wages  of  hired  workers  do  not  rise  as  fast. 

But,  as  has  been  already  said,  and  will  be  more  fully  explained 
at  a  later  stage,1  the  operations  of  capitalists  as  a  class,  and  of 
business  men  as  the  managers  of  investment,  are  resolvable 
into  a  succession  of  advances  to  laborers.  Their  total  expenses 
consist  in  the  last  analysis  in  a  series  of  wages  payments.  To 
the  extent  that  prices  of  commodities  advance  faster  than  ex- 
penses for  the  labor  they  buy,  the  payers  of  wages  gain. 

1  Of  all  these  matters,  more  is  said  in  the  chapters  on  Business  Profits  and 
Wages,  in  Book  VI,  Chapters  49,  50,  51.  Cp.  also  Book  I,  Chapter  5,  §  5. 


CHANGES  IN  PRICES  305 

It  is  familiar  experience  that  those  business  men  gain  most 
in  periods  of  rising  prices  whose  operations  involve  in  largest 
degree  the  payment  of  wages.  The  mere  trader  or  merchant 
usually  gains  least;  the  prices  of  the  things  he  buys  go  up 
almost  as  fast  as  the  prices  of  the  things  he  sells.  The  manu- 
facturer who  buys  few  materials,  and  whose  expenses  are 
chiefly  in  the  direct  purchase  of  labor,  profits  most  of  all.  Such, 
for  example,  is  the  situation  of  a  highly  integrated  enterprise 
like  the  United  States  Steel  Corporation,  which  hires  laborers 
directly  l  to  dig  iron  ore,  mine  coal,  convert  the  coal  into  coke, 
transport  these  materials,  smelt  and  shape  the  iron  and  steel. 
When  the  prices  of  the  iron  and  steel  go  up,  it  gains  hugely, 
since  its  main  outlay,  for  wages  payments,  is  nearly  stable. 
Those  iron  and  steel  makers,  however,  who  have  to  buy  iron 
ore,  or  coal  and  coke,  gain  comparatively  little;  the  prices  of 
their  materials  go  up  pari  passu  with  those  of  their  products. 
The  business  man  who  is  nearest  the  ground,  so  to  speak,  — 
nearest  the  laborer,  —  profits  most  from  the  relative  stability  of 
wages. 

Conversely,  the  business  class  as  a  whole  commonly  loses  in 
periods  of  falling  prices.  Then,  the  same  forces  tending  to 
keep  wages  stable,  a  fall  in  prices  brings  loss.  Probably  wages 
feel  the  effect  of  falling  prices  less  slowly  than  they  do  those 
of  rising  prices.  The  employer's  superior  bargaining  power 
enables  him  more  readily  to  stave  off  the  loss,  just  as  it  aids  him 
in  reaping  the  gain.  But  some  loss  there  is,  for  the  same  funda- 
mental reason,  —  on  him  falls  the  first  effect  of  any  change. 

Whatever  the  business  class  thus  gains  in  periods  of  rising 
prices,  may  appear  to  be  obtained  at  the  cost  of  others; 
and  conversely  as  to  their  loss  from  falling  prices.  What  the 
employers  gain  (in  the  first  case) ,  the  laborers  prima  fade  lose. 
And  it  is  true  that  the  activity  and  prosperity  of  flush  times 
are  a  doubtful  boon  to  the  laborers.2  But  in  one  respect  they 

1  That  is,  through  its  subsidiary  corporations.  Between  the  subsidiary  cor- 
poration there  is  nominal  purchase  of  materials. 

1  It  may  happen  that  money  wages  do  not  overtake  at  all  the  advance  in 
prices.  Such  seems  to  have  been  the  result  of  the  great  price  revolution  of  the 
x 


306   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

seem  really  to  gain ;  employment  is  more  constant,  for  the  pace 
of  industry  is  more  even  as  well  as  more  quick.  Periods  of 
falling  prices  are  more  likely  to  be  periods  of  slackened  enter- 
prise and  irregular  employment.  The  energy  and  consecutive- 
ness  of  operation  depend  largely  on  the  temper  of  the  business 
class.  They  are  the  leaders,  and  on  their  hopes  and  fears 
depends  the  course  of  modern  industry.  The  gains  which  are 
reaped  by  them,  in  times  of  rising  prices,  may  be  needlessly 
high,  and  out  of  proportion  to  their  services  to  society;  but 
in  return  something  is  got  in  the  way  of  unhesitating  and  sus- 
tained activity. 

The  effects  of  falling  and  rising  prices  on  business  profits 
are  modified  in  that  complex  case,  referred  to  in  the  preceding 
section,  where  prices  and  money  incomes  do  not  move  together. 
If  there  be,  in  consequence  of  general  improvements  in  the  arts, 
falling  prices  but  stationary  money  incomes,  it  would  seem  that 
no  depressing  influence  will  be  felt  in  business  circles.  What 
concerns  the  business  man  is  not  price  per  unit  of  product, 
but  total  receipts  from  his  output  compared  with  total  out- 
lays for  that  output.  He  may  pay  out  as  much  per  unit  of 
labor,  and  receive  less  per  unit  of  product,  and  yet  may  make 
profits  because  there  is  more  of  product  per  unit  of  labor,  —  this 
being  the  result  of  greater  efficiency  of  labor.  On  the  other 
hand,  if  there  be  rising  wages  and  rising  prices,  though  prices 
rising  in  the  end  less  high,  —  the  sort  of  movement  which  is 
likely  to  appear  when  there  is  growing  efficiency  of  labor  and  at 
the  same  time  rapid  increase  in  the  money  supply,  —  the  busi- 
ness class  will  feel  an  exhilarating  influence  no  less  than  in  the 
simple  case  of  rising  wages  and  rising  prices.  Though  prices  be 
stationary,  yet  the  total  receipts  from  the  output  will  be  greater, 
since  more  is  turned  out  per  unit  of  labor ;  and  though  wages 
rise,  they  are  likely  to  rise  less  fast  than  gross  receipts.  In  the 
first  case,  the  depressing  effect  of  falling  prices  is  mitigated  or 
overcome  by  improvements  in  production.  In  the  second  case, 

sixteenth  century.  When  this  had  run  its  course,  prices  (of  food,  at  least)  had 
risen  more  than  money  wages,  and  commodity  wages  had  definitively  fallen. 


CHANGES  IN  PRICES  307 

the  stimulating  effect  of  rising  prices  is  accentuated  by  improve- 
ments. The  first  case  seems  to  have  appeared  in  the  period 
of  falling  prices  and  stationary  wages  from  1873  to  1896 ;  the 
second  case  during  the  period  of  rising  wages  and  rising  prices 
during  the  period  that  followed  1896. 

§  7.  Another  influence  of  changing  prices  may  be  on  the 
rate  of  interest.1  If  prices  rise,  the  creditor  loses ;  but  it  may 
be  that  he  will  secure  a  higher  rate  of  interest  at  such  times, 
and  that  this  will  offset  the  loss  from  payment  of  the  principal 
in  depreciated  money.  And  conversely,  if  prices  fall,  the  debtor 
may  get  his  loan  at  a  lower  rate  of  interest,  thus  securing  an 
offset  against  the  loss  to  him  from  lowered  prices.  It  is  con- 
ceivable that  this  sort  of  compensation  will  take  place  steadily, 
even  automatically,  and  that  thereby  all  disturbing  effects  on 
the  relations  between  debtor  and  creditor  will  be  obviated. 

There  can  be  little  question  that  periods  of  rising  prices  are, 
in  fact,  usually  periods  of  higher  interest  rates,  and  that  during 
periods  of  falling  prices  interest  rates  are  lower.  The  explana- 
tion of  this  fact  has  been  the  occasion  of  much  critical  discus- 
sion, and  cannot  be  said  to  be  entirely  clear. 

It  would  seem  to  be  tolerably  certain  that  there  is  no  con- 
scious adjustment  of  the  rate  of  interest  to  changes  in  prices ; 
and  this  for  the  simple  reason  that  such  changes  can  rarely 
be  foretold.  Sometimes,  to  be  sure,  persons  who  are  versed 
in  economic  theory  and  economic  history  believe  that  conditions 
exist  which  will  lead  to  a  rise  in  prices.  Such  was  the  case 
after  the  Californian  and  Australian  gold  discoveries  of  1850; 
such  has  been  the  case  in  recent  years  (1900-1910).  But  the 
rise  in  prices  after  1850  was  much  less  than  had  been  expected 
by  very  competent  persons ; 2  and  it  may  be  that  the  similar 
expectations  held  by  some  good  judges  in  our  own  day  will 

1  The  topic  taken  up  in  this  section  will  be  better  understood  after  reading 
the  chapters  on  Banking  and  Crises  in  the  present  Book,  and  those  on  Interest 
and  Business  Profits  in  Book  VI.  It  may  perhaps  be  postponed  until  these 
have  been  read. 

*  Chevalier,  a  distinguished  economist,  and  by  no  means  a  closet  economist,  im- 
mensely overestimated  the  probable  effects  of  these  gold  discoveries. 


308   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

prove  mistaken.  Certainly  the  fall  in  prices  which  took  place 
after  1873  was  unexpected.  And  whether  or  no  a  few  persons 
can  foresee  price  changes,  the  great  mass  of  lenders  and  bor- 
rowers do  not  even  think  about  them.  Except  in  times  of 
extraordinary  fluctuations  (such  as  are  due  to  paper  money), 
they  regard  money  as  fixed  in  value.  They  reckon  their  gains 
and  losses  as  well  as  their  interest  payments  in  terms  of  money 
only.  They  do  not  trouble  themselves  with  adjustments  of 
the  "real"  rate  of  interest  to  coming  changes  in  prices. 

It  is  possible,  none  the  less,  that  there  may  be  some  adjust- 
ment by  an  unconscious  process.  If  all  who  are  debtors  are 
seen  to  be  gaining  in  times  of  rising  prices,  and  if  it  becomes 
current  opinion  that  buying  on  credit  and  borrowing  are  profit- 
able operations,  there  may  be  a  press  of  demand  for  loans,  and 
so  a  rise  in  the  rate  of  interest.  The  converse  phenomenon  of 
slackened  demand  for  loans  and  low  rates  of  interest  may  show 
itself,  for  reasons  of  the  same  sort,  in  times  of  falling  prices, 
when  those  who  have  borrowed  are  seen  to  be  often  in  straits. 

There  are  other  causes,  however,  which  go  far  to  explain  the 
oscillations  in  demand  for  loans  and  in  the  rate  of  interest. 
Among  these,  and  in  my  judgment  a  weighty  one,  is  the  fact 
of  higher  business  profits  due  to  the  comparatively  slow  advance 
of  money  wages.  Borrowers  are  mainly  "  producers  ";  that  is, 
they  are  mainly  business  men  engaged  in  guiding  the  operations 
of  production.  In  times  when  their  prospects  for  gain  are 
good,  —  and  such  is  the  case  when  wages  lag  behind  rising 
prices,  —  all  want  more  "capital "  ;  that  is,  more  money  means 
that  will  give  them  command  of  more  capital  goods  and  more 
labor.  Though  interest  depends  in  the  long  run  on  other  factors 
than  business  profits,  it  is  derived  proximately  from  business 
profits,  and  follows  these  in  its  ups  and  downs.  The  gains 
which  the  members  of  the  business  class  make  in  times  of  rising 
prices,  and  the  losses  they  incur  with  falling  prices,  go  far  to 
account  for  the  corresponding  oscillations  of  interest. 

Still  another  cause  is  to  be  found  in  the  working  of  the  ma- 
chinery of  credit.  In  the  preceding  paragraphs,  activity  in 


CHANGES  IN  PRICES  309 

business  operations  has  been  spoken  of  as  a  result  of  rising 
prices.  But  it  is  also  a  cause  of  rising  prices.  Even  though  there 
be  no  influence  of  a  distinctly  monetary  sort  (such  as  an  in- 
crease in  the  specie  supply),  prices  may  go  up  from  the  general 
expansion  of  credit,  —  a  phenomenon  of  which  more  will  be 
said  in  its  proper  place.1  It  suffices  here  to  point  out  that,  as 
between  active  times  with  high  rates  of  interest  and  dull  times 
with  low  rates  of  interest,  there  is  an  interaction  of  cause  and 
effect;  or,  more  accurately  perhaps,  there  are  sundry  effects 
all  due  to  one  commanding  cause.  Both  rising  interest  and 
rising  prices  are  in  large  degree  due  to  a  common  cause,  —  the 
general  fever  of  activity ;  and  both  falling  interest  and  falling 
prices  are  promoted  by  a  common  cause  of  the  same  sort,  —  in- 
dustrial lethargy. 

Certain  it  is  that  there  is  no  exact  or  automatic  relation 
between  fluctuations  in  prices  and  fluctuations  in  the  rate  of 
interest.  Some  writers  have  supposed  there  is ;  that  when 
prices  fall,  interest  so  falls  that  the  debtor's  gain  in  the  interest 
rate  offsets  his  loss  from  lower  prices.  Conversely,  when  prices 
rise,  interest  is  supposed  to  rise  just  enough  to  offset  the  credi- 
tor's loss.  But  such  adjustment  as  statistical  inquiry  reveals 
seems  to  be  but  partial ;  the  creditor  or  debtor,  so  far  as  they 
get  alleviation  from  shifting  interest  rates,  get  only  a  partial 
alleviation.  And  this  partial  alleviation  is  not  the  result  of  any 
conscious  adjustment,  still  less  of  any  automatic  correction 
of  inequities  in  debt  payments.  The  roughly  parallel  move- 
ments of  prices  and  rates  of  interest  are  not  explicable  in  the 
main  from  anything  in  the  way  of  calculation  by  debtors  and 
creditors.  If  this  process  tends  to  promote  equity  in  the  deal- 
ings between  these  classes  under  the  existing  monetary  regime, 
it  is  partly  the  result  of  other  causes  acting  on  the  interest 
rate,  but  mainly  because,  after  all,  fluctuations  in  prices  are 
slow  and  their  effect  in  disturbing  the  outcome  of  most  credit 
transactions  not  considerable. 

1  Chapter  29,  especially  §  3. 


CHAPTER  23 
GOVERNMENT  PAPER  MONEY 

§  1.  In  this  chapter  we  shall  consider  paper  money  issued 
by  governments,  and  particularly  inconvertible  or  irredeemable 
paper  money.  All  paper  money  contains  on  its  face  a  promise 
to  pay;  but  in  the  case  of  government  paper  that  promise  is 
more  often  broken  than  kept.  The  most  perplexing  and  at 
the  same  time  most  instructive  problems  relating  to  paper 
money  arise  when  it  is  not  what  on  its  face  it  purports  to  be, 
—  when  it  is  not  convertible  into  specie. 

Inconvertible  paper  has  been  called  fiat  money,  because  its 
use  as  money  and  its  value  depend  on  the  mere  command  of 
the  political  authority.  The  extent  to  which  the  edict  of  the 
sovereign  or  legislature  can  cause  a  scrap  of  paper  to  serve  as 
money,  and  to  maintain  its  value  as  money,  may  be  both  over- 
stated and  understated.  Historically,  all  money  has  had  its 
origin,  directly  or  indirectly,  not  in  any  compulsion  or  even 
in  any  deliberate  selection,  but  in  the  customary  acceptance  of 
some  commodity  of  general  serviceability.  When,  however, 
such  a  commodity  has  once  come  to  be  habitually  used  as 
money,  public  authority  can  very  much  'affect  its  value  and 
the  mode  in  which  it  circulates.  Paper  pieces,  similarly,  can 
be  made  to  serve  as  money  by  mere  government  fiat  only  when 
a  people  has  already  become  habituated  to  the  use  of  a  paper 
medium  of  exchange.  Modern  communities  began  using 
money  of  this  sort  on  a  considerable  scale  in  the  latter  part  of 
the  seventeenth  century,  when  public  and  semi-public  banks 
issued  promises  to  pay,  which  readily  passed  into  circulation 
because  really  convertible  into  specie.  By  the  eighteenth  cen- 
tury, paper  substitutes  for  metallic  money  had  become  so  fa- 
miliar that  the  way  was  easy  for  the  issue  by  public  authorities 

310 


GOVERNMENT  PAPER  MONEY  311 

of  inconvertible  paper.  Partly  by  taking  advantage  of  the 
established  habit,  partly  by  mere  force  of  law,  governments 
found  it  possible  to  make  promises  to  pay  that  were  only 
nominal  circulate  as  freely  as  gold  and  silver. 

Let  it  be  assumed  that  those  conditions  exist  without  which 
there  can  be  no  circulation  of  inconvertible  paper,  —  some  habit- 
uation  to  paper  promises  to  pay,  and  a  strong  government. 
Let  it  be  assumed  further  that  the  government  exerts  its 
strength  to  bolster  up  the  paper  which  it  issues.  This  is  done 
commonly  by  making  the  paper  a  legal  tender  for  debts  (i.e. 
for  those  expressed  simply  in  current  money)  and  by  making  it 
receivable  at  its  face  value  for  taxes  and  other  public  dues. 
Suppose  that  by  these  means  the  paper  is  made  to  circulate 
freely,  passing  from  hand  to  hand  as  readily  as  specie.  What 
then  determines  its  value  ? 

Evidently,  the  reasoning  already  set  forth  as  to  metallic 
money  will  hold  good  of  paper  money  also  :  its  value,  too,  will 
be  determined  by  its  quantity.  If  it  is  issued  in  the  same 
quantity  as  the  specie  previously  in  circulation,  and  if  it  com- 
pletely displaces  that  specie  (as  ordinarily  it  will),  the  range  of 
prices  will  be  precisely  what  it  was  before,  and  the  value  of  the 
paper  will  be  as  great  as  that  of  the  specie  had  been.  If  it  be 
issued  in  twice  the  quantity  of  the  specie,  prices  will  be  doubled, 
and  the  value  of  money  will  be  one  half.  These  statements  are 
subject  to  the  same  qualifications  that  would  have  to  be  applied 
to  specie  itself.  They  assume  that  rapidity  of  circulation  remains 
the  same,  and  that  the  quantity  of  commodities  and  their  mode  of 
coming  to  market  remain  the  same,  —  qualifications  which  have 
been  already  discussed.  They  assume,  too,  that  the  use  of  credit 
substitutes  for  money,  and  especially  the  bank  methods  of 
credit,  are  unchanged, — important  qualifications  which  remain 
to  be  considered.  Yet  all  these  corrections  in  no  sense  touch 
the  essential  truth ;  the  value  of  freely  circulating  paper  money 
depends  on  its  quantity.  Though  it  be  quite  inconvertible, 
though  there  be  no  prospect  of  its  redemption  in  specie,  it  will 
retain  its  value  and  perform  all  the  functions  of  money.  It  will 


312   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

obviously  have  a  prima  fade  advantage  over  specie,  in  that  it 
will  cost  the  country  less.  Gold  and  silver  can  be  produced 
only  with  much  labor.  Paper  money  costs  but  a  trifle.  A 
cheap  and  apparently  serviceable  medium  of  change  is  sub- 
stituted for  a  dear  one. 

All  this,  to  repeat,  rests  on  the  supposition  that  the  paper 
money  circulates  freely.  It  does  not  necessarily  circulate  freely. 
Conceivably,  people  will  distrust  the  government,  or  dislike  to 
use  paper,  or  for  whatever  reason  refuse  to  accept  it  readily 
in  current  transactions.  Then  it  will  either  not  get  into  cir- 
culation at  all,  or  it  will  have  a  value  determined  in  a  different 
way.  Of  this  sort  of  possibility  a  striking  illustration  appeared 
in  the  state  of  California  during  and  after  our  Civil  War,  from 
1862  to  1879.  The  government  of  the  United  States  issued 
paper  money  in  such  a  quantity  as  to  cause  prices  to  rise  and 
the  money  to  depreciate.  In  California,  as  in  other  states,  the 
paper  was  legal  tender,  and  was  receivable  for  public  dues; 
nor  was  there  any  distrust  or  hostility  towards  the  federal 
•government.  But  there  was  a  strong  feeling  —  call  it  preju- 
dice or  reasonable  preference  —  in  favor  of  gold  and  against 
paper;  a  feeling  due  to  the  fact  that  California  was  then  in 
the  first  stage  of  her  great  gold  discoveries,  and  that  gold  was 
a  plentiful  medium  for  all  transactions.  Every  debtor  had  the 
legal  right  to  pay  off  his  debts  in  depreciated  paper.  But  if 
he  did  so,  he  was  a  marked  man  (the  creditor  was  likely  to  post 
him  publicly  in  the  newspapers),  and  he  was  virtually  boy- 
cotted. Throughout  this  period  paper  was  not  used  in  Cali- 
fornia. The  people  of  the  state  conducted  their  transactions 
in  gold,  while  all  the  rest  of  the  United  States  used  the 'incon- 
vertible paper.1 

The  same  factor  —  widespread  unwillingness  to  use  the  paper 
—  affects  its  circulation  and  value  with  highly  dramatic  effect, 
when  a  government  grossly  abuses  the  possibilities  of  the  case, 
and  issues  it  in  great  and  constantly  increasing  quantity.  Then 

1  See  Moses,  "Legal  Tender  Notes  in  California,"  Quarterly  Journal  oj 
Economics,  Vol.  VII,  p.  1. 


GOVERNMENT  PAPER  MONEY  313 

the  stage  may  be  reached  when  no  one  will  longer  accept  the 
paper,  and  when  the  bottom  completely  drops  out  of  it.  Its 
value  then  falls  not  only  because  its  quantity  is  very  great,  but 
because  people  are  no  longer  willing  to  accept  it  in  exchange  for 
goods.  Its  supply  is  increased ;  and  at  the  same  time  the  demand 
for  it  (the  offer  of  goods  for  money)  declines,  — may  even  cease 
entirely.  Such  was  the  case  with  the  notes  which  the  Scotch 
schemer  and  adventurer,  Law,  persuaded  the  French  govern- 
ment to  issue  in  1720.  They  were  put  forth  in  such  enormous 
and  unceasing  amounts  that  they  completely  lost  acceptability 
and  depreciated  to  nothing.1  Such  was  the  case  with  the  paper 
money  issued  by  the  American  Congress  during  the  Revolution. 
Continental  money  was  printed  in  amounts  so  vast  that  it  be- 
came utterly  distrusted,  and  depreciated  much  more  than  in 
proportion  to  its  quantity  (whence  the  saying,  "not  worth  a 
Continental  ")•  Such,  too,  was  the  case  with  the  assignats  of  the 
French  Revolution  in  1790-1796,  when  the  French  government 
put  out  notes  which  at  first  were  redeemable  in  land,  but  soon 
were  poured  forth  without  pretense  of  any  redemption,  and  in 
such  unlimited  quantities  that  they  became  quite  worthless. 
Still  later,  in  1864-1865,  the  same  was  the  fate  of  the  paper 
money  of  the  Southern  Confederacy. 

But  no  such  extremity  of  depreciation  has  been  reached  in 
more  recent  instances.  During  the  nineteenth  century  many 
countries  resorted  to  issues  of  paper  money,  and  depreciation 
commonly  ensued.  Yet,  with  the  exception  of  the  hapless  South- 

1  The  breakdown  of  confidence  in  the  paper  seems  to  have  taken  place  in 
this  case  with  dramatic  suddenness.  An  effort  by  the  government  to  put  a  limit 
to  depreciation  caused  an  unexpected  and  utter  collapse.  "During  the  first 
stages  of  depreciation,  "  strange  as  it  may  appear,  the  deterioration  of  the  notes 
in  value  does  not  appear  to  have  affected  their  circulation.  All  that  people 
looked  to  was  nominal  value,  and  while  the  notes  were  called  livres,  nobody 
inquired  what  a  livre  meant.  But  the  instant  the  denomination  was  altered ; 
the  instant  government  declared  that  a  note  for  ten  livres  should  be  worth  only 
five, — the  baselessness  of  the  paper  fabric  was  detected.  The  terror  was  as 
universal  and  as  blind  as  the  confidence  had  been.  To  use  Sir  James  Steuart's 
words,  on  the  22d  of  May,  a  man  with  one  hundred  millions  of  bank  notes  might 
have  starved  in  the  street."  SENIOR,  Three  Lectures  on  the  Cost  of  Obtaining 
Money,  p.  76.  The  reference  is  to  Sir  James  Steuart's  Principles  of  Political 
Economy,  Part  II,  Chapter  59  (Vol.  Ill,  p.  52,  edition  of  1770). 


314   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

ern  Confederacy  during  our  Civil  War,  no  important  country 
in  the  nineteenth  century  carried  the  process  so  far  that  con- 
fidence in  the  paper  was  completely  lost.  Very  considerable 
issues  have  been  made,  under  conditions  which  enabled  the 
paper  to  maintain  its  circulation  and  to  depend  for  its  value  on 
its  quantity.  This  sort  of  situation,  less  extreme  but  in  many 
ways  less  simple  than  the  kind  already  illustrated,  will  be 
mainly  discussed,  in  the  following  sections. 

§  2.  Paper  money,  whether  convertible  or  inconvertible,  tends 
to  drive  out  specie.  The  expulsion  takes  place  through  the  opera- 
tions of  international  trade.  The  newly  issued  paper  enlarges  the 
quantity  in  circulation,  and  sooner  or  later  raises  prices.  The  rise 
in  prices  causes  imports  to  be  greater,  exports  to  be  less;  and 
specie  flows  out  in  payment  of  the  imports.  Paper  money,  of 
course,  does  not  flow  out;  it  cannot  circulate  in  foreign  coun- 
tries. The  mechanism  is  not  usually  so  simple  as  this ;  sundry 
complications  in  its  working  will  appear  when  the  subject  of 
foreign  trade  is  reached  for  detailed  consideration.  But  in 
essentials  the  process  is  here  stated  correctly.  Specie  disap- 
pears through  the  channels  of  international  trade,  in  propor- 
tion as  paper  money  is  issued.  If  half  as  much  paper  is  put  out 
as  the  specie  previously  in  circulation,  the  medium  of  exchange 
will  become  half  paper,  half  specie.  If  exactly  as  much  paper  is 
put  out,  all  the  specie  will  disappear,  and  only  paper  will  re- 
main. And  a  fortiori  this  will  be  the  case  if  the  paper  exceeds  in 
quantity  the  specie  previously  used.1 

This  last  stage  is  that  of  "overissue"  ;  that  is,  of  issue  beyond 
the  point  where  prices  remain  the  same  as  under  a  specie 
regime.  Any  added  quantity  of  paper,  beyond  this  point,  is  no 
longer  offset  by  an  equivalent  expulsion  of  specie,  but  creates  an 
abnormal  level  of  prices.  All  the  consequences  of  such  a  rise 
show  themselves.  Creditors  lose,  debtors  gain.  Prices  of  com- 

1  Theoretically,  these  statements  require  a  correction,  because  the  outflow 
of  specie  will  raise  prices  in  foreign  countries,  and  so  affect  the  whole  inter- 
national level  and  therefore  the  relation  of  paper  to  specie  in  the  issuing  country. 
But  this  correction  is  of  no  real  importance  in  the  experience  of  countries  that 
have  resorted  to  paper. 


GOVERNMENT  PAPER  MONEY  315 

modities  rise  faster  than  do  ordinary  wages,  and  faster  than 
those  incomes  which  are  called  "fixed,"  because  strongly  affected 
by  custom.  Business  men  make  money.  The  rate  of  interest 
rises.  An  exhilaration  is  felt  in  the  industrial  world,  precisely 
as  when  prices  rise  from  added  supplies  of  specie. 

The  exhilaration  lasts  so  long,  and  only  so  long,  as  the  process 
is  kept  up.  It  is  the  result  not  of  higher  prices,  but  of  rising 
prices.  When  once  the  higher  level  is  reached  all  around, 
quiescence  comes ;  nay,  as  a  rule,  lethargy.  The  effect  is  like 
that  of  a  drug ;  when  the  stimulus  no  longer  acts,  a  reaction  sets 
in.  One  of  the  recurring  phenomena  of  periods  of  rising 
prices,  whether  from  specie  or  paper,  is  the  complaint  that 
there  is  not  enough  money.  However  much  the  quantity  of 
money  may  have  been  increased,  people  aver  there  is  not  enough 
"to  do  the  business,"  or  not  enough  "to  finance  prosperity." 
This  simply  means  that  prices  have  been  adjusted  to  the  in- 
creased supply,  that  the  upward  movement  has  reached  its 
term,  and  that  the  pleasant  stage  of  apparently  advancing  pros- 
perity has  come  to  an  end. 

Hence  there  always  springs  up  a  plentiful  crop  of  persons  who 
advocate  still  further  additions  to  the  monetary  supply.  Most 
people  have  only  vague  notions  of  what  money  is,  what  are  its 
functions,  how  it  affects  prosperity.  Their  instinctive  attitude 
is  almost  always  that  of  welcoming  an  increase  in  the  money  sup- 
ply. Especially  during  and  after  periods  of  rising  prices,  the 
panacea  of  ever  plentiful  money  has  many  ardent  advocates. 
Sober  sense  sooner  or  later  returns  to  the  great  mass  of  the  com- 
munity, and  the  projects  of  fiat-money  advocates  are  brushed 
aside.  But  one  of  the  greatest  objections  to  paper  issues  is 
the  unsettlement  which  they  cause  in  people's  ideas  on  the 
nature  and  effects  of  money.  Absurd  notions  emerge,  and  the 
simplest  lessons  of  economics  must  be  retaught.  The  right  ad- 
justment of  the  monetary  system  — •  intrinsically  a  task  of  no 
small  difficulty  —  has  to  be  undertaken  in  face  of  a  tumult  of 
ignorance,  passion,  and  dishonesty. 

When  paper  has  been  issued  in  such  amounts  as  to  cause  a 


316   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

rise  in  prices  above  the  level  at  which  they  would  have  stood 
Under  a  specie  standard,  specie  ceases  to  circulate  and  becomes 
itself  a  commodity.  Paper  becomes  the  sole  medium  of  ex- 
change, and  gold  (or  silver,  as  the  case  may  be)  js  bought  and 
sold  at  prices  in  paper,  like  other  things.  In  precisely  the  same 
way,  after  the  gold  standard  established  itself  in  the  civilized 
countries,  silver,  being  no  longer  a  full  money  metal,  was  bought 
and  sold  in  terms  of  gold,  Under  a  regime  of  overissued  paper 
gold  sells  at  a  premium  in  paper,  and  paper  is  depreciated  in 
terms  of  gold.  The  paper  is  a  nominal  promise  to  pay  in  gold, 
but  is  not  equal  in  value  to  the  gold  which  it  purports  to  repre- 
sent. Hence  the  price  of  gold  is  commonly  stated,  not  in  terms 
of  so  much  per  ounce  or  pound,  but  in  terms  of  itself,  so  to  speak, 
—  how  many  paper  "dollars"  are  needed  to  buy  one  gold  dollar. 

Gold  never  disappears  entirely  from  such  a  country,  even  though 
it  ceases  to  be  the  medium  of  exchange  and  disappears  from 
ordinary  circulation.  Some  gold  is  always  wanted  for  use  in  the 
arts;  and  for1  these  uses  it  is  bought  and  sold,  like  copper  or 
nickel.  Some  is  commonly  wanted  also  for  transactions  which 
are  by  special  stipulations  to  be  carried  out  in  gold.  A  class  of 
dealers  in  gold  usually  appears,  who  make  it  a  business  to  buy 
and  sell  this  metal,  as  other  dealers  do  with  the  commoner  metals. 

The  premium  on  gold  roughly  measures  the  depreciation  of  the 
paper,  but  measures  it  no  more  than  roughly.  The  real  deprecia- 
tion of  the  paper  is  the  rise  in  prices.  That  could  be  measured, 
more  or  less  accurately,  by  the  index-number  method.  But 
any  rise  in  prices  is,  as  we  have  seen,  irregular.  Some  com* 
modities  advance  more  than  others,  some  not  at  all,  some  decline. 
The  change  in  any  one  may  or  may  not  be  such  as  to  indicate 
the  general  change.  So  it  is  with  the  price  of  gold,  or  the  specie 
premium.  It  is  subject  to  influences  of  its  own,  among  the  most 
important  of  which  is  the  demand  for  remittances  abroad,  — 
the  necessary  use  of  gold  in  transactions  with  foreign  countries. 
Sometimes  these  special  influences  cause  the  premium  to  be  in 
advance  of  the  general  rise  in  price,  sometimes  to  lag  behind. 

Yet  the  divergencies  between  the  specie  premium  and  the  real 


GOVERNMENT  PAPER  MONEY  317 

depreciation  of  the  paper,  though  sometimes  very  pronounced,  are 
not  likely  to  endure  long  on  a  considerable  scale.  The  premium 
usually  indicates  with  fair  accuracy  the  real  depreciation  of  paper 
money.  If  the  premium  on  the  average  is  about  100  (i.e.  if  200 
of  paper  are  needed  to  buy  100  of  gold),  we  may  infer  that  paper 
prices  are  about  double  what  gold  prices  would  be.  If  the 
premium  is  somewhere  between  10  and  20,  as  it  was  in  the 
United  States  during  the  years  from  1870  to  1876,  which  pre- 
ceded the  return  to  a  specie  standard,  we  may  be  sure  that  prices 
in  general  are  somewhat  higher,  but  not  greatly  higher,  than 
they  would  be  in  gold.  And  when  the  premium  steadily  de- 
clines over  a  period  of  years,  we  may  infer  that  paper  prices 
are  coming  nearer  to  what  gold  prices  would  have  been, — 
that  they  either  are  falling,  or  are  failing  to  rise  as  gold  prices 
elsewhere  are  rising. 

One  of  the  factors  which  lead  to  special  fluctuations  in  the  gold 
premium  is  the  prospect  of  the  redemption  of  the  paper  in  gold. 
Paper  money  is  rarely  issued  with  the  intention  or  expectation 
that  it  will  depreciate.  The  issue  commonly  takes  place  under 
stress,  as  a  supposedly  temporary  expedient,  with  little  time 
for  deliberation,  and  with  a  desire  to  return  as  soon  as  possible 
to  a  specie  basis.  Any  event  which  makes  early  redemption 
in  specie  probable,  lowers  the  premium ;  any  untoward  event 
raises  it.  When  Napoleon  broke  loose  from  Elba  in  1814,  the 
premium  on  gold  in  England  rose ;  when  the  news  of  Water- 
loo came,  it  fell  sharply.  In  the  United  States,  the  premium 
fell  at  once  after  the  battle  of  Gettysburg,  and  rose  high  during 
the  anxious  summer  of  1864.  Such  abrupt  turns  have  led  to  the 
statement  that  confidence  in  the  paper  money  governs  its  value, 
or  at  least  greatly  affects  its  value.  It  is  more  legitimate  to  say 
that  confidence  in  redemption  affects  the  value  of  the  specie. 
General  prices  do  not  move  up  and  down  under  the  influence  of 
military  or  political  fortunes.  It  is  the  price  of  specie  that  is 
affected ;  for  dealers  and  speculators  discount  at  once  the  con- 
sequences for  the  financial  stability  of  the  government  and  for 
the  possible  resumption  of  specie  payments. 


318   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

§  3.  Of  the  various  phenomena  connected  with  paper  money, 
no  better  illustration  can  be  found  than  in  the  experience  of  the 
United  States  from  1862  to  1879,  to  which  references  have  al- 
ready been  made.  During  the  Civil  War,  in  1862-1865,  great 
quantities  of  inconvertible  paper  were  issued,  far  in  excess  of 
the  specie  previously  in  circulation.  Prices  rose  rapidly,  and  at 
the  close  of  1864  were  at  least  double  what  they  had  been  in 
1861.  The  specie  premium  rose  in  the  same  degree,  and  at  one 
time  (in  July,  1864)  was  at  the  extraordinary  height  of  185; 
that  is,  a  dollar  of  gold  sold  for  $2.85  in  paper.  Immediately 
after  the  close  of  the  war,  in  1865,  some  parts  of  the  paper 
money  issues  were  withdrawn;  prices  fell  sharply,  and  the 
price  of  gold  dropped  to  about  150.,  i.e.  the  gold  premium  sank 
to  50.  Throughout  all  these  stirring  and  anxious  years,  the 
paper  continued  to  circulate  readily  (except  in  distant  Cali- 
fornia), and  with  no  such  loss  of  confidence  as  comes  from 
complete  discredit  of  the  issues.  The  quantity,  though  reduced 
in  1865,  still  remained  redundant,  and  depreciation  lasted  for 
many  years,  until  finally  in  1879  specie  payments  were  resumed. 
The  process  by  which  prices  were  brought  to  the  gold  level  and 
by  which  the  real  depreciation  of  the  paper  was  ended,  was 
rather  that  of  growing  demand  for  money,  because  of  the  in- 
crease of  population  and  wealth,  than  of  lessening  the  supply 
of  money  through  retirement  of  a  large  part  of  the  paper.  It 
was  a  process  not  inaptly  called  "  growing  up  to  the  currency." 

The  course  of  events  is  illustrated  by  the  chart,  which  shows 
the  range  of  prices  during  the  period  from  1860  to  1880.  The 
index  number  which  best  indicates  the  course  of  prices  is  the 
median,  not  the  arithmetic  mean;  because,  for  some  of  the 
years  of  greatest  fluctuation,  the  arithmetic  mean  was  unduly 
affected  by  the  extreme  prices  of  a  few  commodities.  Nothing 
could  show  better  the  evils  of  excessive  paper  money  than  the 
soaring  line  of  1862-1865,  and  the  sinking  line  of  later  years; 
the  inequities  between  debtor  and  creditor,  the  instability  of 
pecuniary  relations,  the  slow  and  painful  process  of  return  to 
the  normal  standard.1 


GOVERNMENT  PAPER  MONEY 


319 


A 


E 


r 


s     i 


§ 


§      2     I      8 

1  The  chart  is  based  on  the  figures  given  in  Mitchell's  Gold,  Prices,  and  Wages 
under  the  Greenback  Standard,  pp.  59,  60.  No  more  careful  inquiry  into  the 
history  of  prices  has  been  made  than  is  contained  in  this  admirable  monograph. 
None  the  less,  some  of  the  phenomena  of  the  period  are  not  yet  fully  understood, 
especially  the  great  rise  in  prices  in  1864-1865. 

For  comparison,  the  chart  shows  the  course  of  prices  in  Germany  as  well  as  in 
the  United  States ;  the  index  numbers  for  Germany  being  calculated  from  the 
prices  of  precisely  the  same  articles  as  for  the  United  States.  For  each  country, 
both  the  arithmetic  means  and  the  medians  are  shown.  The  divergence  of  the 
two  sets  of  lines  indicates  unmistakeably  the  effect  of  the  American  paper  issues. 


320  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

It  was  during  the  ten  years,  more  or  less,  preceding  the  re- 
sumption of  specie  payments,  that  the  paper  money  advo- 
cates had  their  opportunity.  Then  all  sorts  of  fallacies  about 
the  blessings  of  plentiful  money  had  vogue.  The  controversy 
led,  as  is  inevitable  in  a  democratic  community,  to  a  long 
succession  of  compromises.  One  of  these  was  the  act  for  the 
resumption  of  specie  payments  itself.  Still  another  result  of 
this  unsettled  period  was  the  injection  of  silver  into  the  currency 
under  the  acts  of  1878  and  1890.1 

§  4.  History  shows  that  overissue,  always  threatened  by 
paper  money,  has  rarely  been  avoided.  Resort  to  this  easy  way 
of  meeting  public  expenditures  has  usually  been  the  conse- 
quence of  war.  Though  Law's  notes  of  1720  in  France  were  not 
due  directly  to  military  needs,  the  other  well-known  cases  of  notes 
utterly  discredited, — the  assignats  of  the  French  Revolution,  the 
Continental  money  of  our  own  War  of  Independence,  the  Con- 
federate notes  of  1862-1865,  —  all  arose  from  the  stress  of  war. 
Other  issues  which  reached  the  stage  of  depreciation,  though 
not  of  complete  collapse,  were  due  to  the  same  sort  of  stress. 
England  resorted  to  paper  money  (in  the  form  of  Bank  of 
England  notes,  made  inconvertible  by  law)  during  the  Napoleonic 
wars.  Prussia,  during  the  same  period,  turned  to  direct  state  is- 
sues. Austria  long  had  a  much  discredited  paper  money.  Not- 
withstanding endeavors  to  resume,  the  wars  of  1853,  1859,  1866, 
kept  Austria  to  a  paper  money  regime,  until,  in  very  recent  times, 
she  has  succeeded  in  regaining  specie  equivalence.  Russia, 
until  our  own  time,  has  hardly  known  what  specie  money  means. 
Spain,  Portugal,  the  South  American  countries,  all  have  fallen 
into  the  paper  money  slough,  and  most  have  not  yet  extricated 
themselves.  The  United  States,  as  we  have  seen,  had  her 
trying  experience  during  and  after  the  Civil  War.  It  deserves  to 
be  noted,  too,  that  the  War  of  1812-1815  brought  the  United 
States  to  the  verge  of  government  issues.  Had  that  war  lasted 
a  little  longer,  the  final  step  toward  a  paper  regime  would  prob- 
ably have  been  taken.  The  cases  of  resort  to  paper,  without  en- 

1  Cf.  Chapter  21,  §  4. 


GOVERNMENT  PAPER  MONEY  321 

suing  depreciation  and  unsettlement,  can  be  counted  on  the  fin- 
gers of  one  band.  The  most  notable  is  that  of  France  in  the  War 
of  1870-1871.  The  notes  of  the  Bank  of  France  (which  were 
made  virtually  government  paper,  not  exchangeable  for  specie), 
were  issued  in  large  amounts  to  aid  the  government  in  its  finan- 
cial exigencies  during  and  after  that  great  struggle.  Yet  the 
situation  was  handled  with  such  caution  and  skill  that  only  a 
slight  specie  premium  appeared,  lasting  a  short  time  only.  The 
possible  gain  from  a  resort  to  paper  was  secured  in  this  case 
without  any  serious  drawback.1 

The  probability  of  overissue,  with  all  its  disturbing  conse- 
quences, is  the  main  ground  for  condemning  paper  money.  To 
this  must  be  added  the  corresponding  disturbance  of  the 
reverse  process,  —  the  return  to  specie  payments.  So  un- 
settling is  a  paper  money  regime  that  no  community  has  will- 
ingly retained  it,  and  every  advanced  country  which  has  fallen 
into  it  has  sooner  or  later  extricated  itself.  Though  paper  money 
may  do  all  the  work  of  a  circulating  medium,  it  does  so  with  a 
constant  prospect  of  backsliding.  Whether  there  is  enough  of  it, 
or  too  much,  or  too  little,  is  always  a  matter  in  the  discretion  of 
the  government  for  the  time  being.  The  value  of  specie  is 
deeply  rooted  in  the  established  ways  of  mankind.  For  any 
one  country,  its  value  is  not  within  the  control  of  legislation  at 
all.  Its  international  acceptance  gives  it  a  basis  on  which  the 
currency  system  of  a  country  can  rest  securely.  Hence  every 
capable  and  ambitious  community  which  has  resorted  to  paper 
money  resolves  in  the  end,  even  at  great  sacrifice,  to  get  back 
to  specie. 

A  difficult  problem  sometimes  presents  itself  as  to  the  way  in 
which  the  return  to  a  specie  basis  shall  take  place ;  whether  by 
redeeming  the  paper  at  its  face  value  in  specie,  or  at  its  mar- 
ket value.  The  first  course  has  the  bracing  effect  of  recogniz- 
ing a  promise  to  pay  as  really  a  promise,  and  of  meeting  it  to  the 
letter.  The  second,  however,  may  be  more  substantially  equita- 
ble where  the  paper  money  has  been  depreciated  for  a  long  time. 

iCf,  Chapter  26,  53, 
Y 


322   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

Then  the  injustice  caused  between  debtors  and  creditors  can  no 
longer  be  undone.  A  new  generation  has  come  on  the  scene,  and 
has  made  its  engagements  on  the  basis  of  paper.  To  shift  these 
into  specie  engagements,  with  a  transition  to  prices  presumably 
lower,  is  to  injure  present  debtors  as  much  as  past  creditors 
were  injured.  Hence  if  the  paper  is  depreciated,  say  one  third 
(the  price  of  gold  being  150  in  paper),  and  if  it  has  been  de- 
preciated to  this  extent  for  many  years,  the  most  equitable  plan 
is  to  redeem  it  in  gold  at  two  thirds  of  its  nominal  value.  This  is 
done  most  simply  by  creating  a  new  coin  having  two  thirds  of  the 
gold  content  of  the  former  coin.  The  existing  paper  standard, 
and  the  existing  range  of  prices  and  incomes,  are  thereby  recog- 
nized once  for  all,  but  are  anchored  for  the  future  to  a  firm  specie 
basis.  This  is  substantially  what  Austria  and  Russia  have  done 
in  their  resumption  operations  of  recent  years.1 

But  where  the  paper  money  is  not  of  long  standing ;  where 
the  community  has  not  become  habituated  to  any  sustained 
and  fairly  constant  depreciation;  where  return  to  a  specie 
standard  has  been  steadily  expected,  and  has  been  borne  in  mind 
as  at  least  a  possibility  by  all  lenders  and  borrowers,  —  there 
the  sound  policy  is  to  resume  at  par.  Redeem  the  paper  at  its 
full  nominal  value,  and  maintain  the  good  tradition  that  a  dol- 
lar is  a  dollar.  Doubtless  it  is  a  half-illusory  tradition.  The 
gold  dollar  is  not  necessarily  a  stable  dollar.  But  it  is  a  dollar 
more  stable  than  any  which  the  legislation  of  a  particular  coun- 
try is  likely  to  devise  by  itself.  In  this  matter,  as  in  so  many 
others,  it  is  well  that  sound  rules  of  general  expediency  should 
crystallize  into  moral  precepts.  The  doctrine  that  it  is  honest  to 
redeem  a  paper  dollar  in  gold  at  its  face  value,  no  doubt  implies 
more  as  to  the  nature  of  " honesty"  than  the  average  man  will 
understand,  but  is  not  to  be  caviled  at  unless  there  be  very  seri- 

1  This,  too,  is  what  Japan  did  when  she  changed  from  a  silver  to  a  gold  basis 
in  1897.  It  is  true  that  Japan  did  not  have  paper  money ;  her  currency  was 
based  on  silver,  which  had  been  depreciating,  with  reference  to  gold,  as  the  price 
of  silver  fell  after  1873.  Determined  to  adopt  the  ways  of  advanced  countries, 
Japan  turned  to  the  gold  standard,  and  established  a  new  coin,  the  gold  yen, 
equal  in  value  to  the  silver  yen  as  it  stood  at  the  time. 


GOVERNMENT  PAPER  MONEY  323 

ous  grounds  for  questioning  the  substantial  balance  of  equity  in 
favor  of  specie  in  general  and  gold  in  particular. 

At  all  events,  the  return  to  specie  payments  has  commonly 
taken  place  by  resumption  at  par.  This  was  the  case  in  Eng- 
land after  the  Napoleonic  wars;  it  was  the  case  in  Italy,  in 
the  resumption  of  1883  (then  half-hearted  and  unsuccessful, 
and  only  in  recent  years  really  accomplished).  It  was  the  case 
in  the  United  States  in  1879.  Austria  and  Russia,  which  have 
just  been  referred  to  as  changing  from  paper  to  gold  on  the 
basis  of  the  market  value  of  their  paper,  had  the  excuse  that 
"specie"  for  them  might  have  meant  either  silver  or  gold. 
Their  paper  had  been  issued  at  a  time  when  silver  was  the 
familiar  and  accepted  monetary  metal  in  most  parts  of  the 
world  and  in  their  own  boundaries.  They  returned  to  specie 
at  a  time  when  gold  had  become  the  accepted  metal,  and  when 
silver  had  much  depreciated  in  terms  of  gold.  The  establish- 
ment of  a  new  gold  standard  took  place,  reasonably  enough, 
on  the  basis,  not  of  depreciated  silver,  but  of  new  gold  coins 
representing  the  market  value  of  the  paper  in  the  period  of 
resumption. 

§  5.  An  interesting  case,  illustrating  in  another  way  how 
the  quantity  of  money  acts  on  its  value,  is  that  of  what  may 
be  called  inconvertible  specie.  The  conspicuous  instance  is 
the  rupee  of  British  India.  It  is  a  silver  coin,  having  about 
the  same  content  of  fine  silver  (165  grains)  as  forty-four  cents 
of  the  American  silver  dollar.  Formerly  it  was  freely  coined 
at  the  mints  of  British  India ;  that  great  region  had  the  single 
silver  standard.  When  the  fall  in  the  price  of  silver  set  in 
after  1873,  the  rupee  began  to  depreciate  in  terms  of  gold. 
The  fall  of  silver  had  important  effects.  It  necessarily  influenced 
the  foreign  trade  of  India ;  it  influenced  also  the  finances  of  the 
Indian  government.  That  government  has  large  payments  to 
make  in  England,  almost  always  in  gold.  It  collects  its  revenue 
in  silver  in  India.  The  lower  the  price  of  silver  in  terms  of 
gold,  the  farther  will  the  Indian  revenues  fall  short  of  meeting 
gold  payment  in  England.  When  silver  sold  in  London  at 


324   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

about  6  Id.  per  ounce  (i.e.  when  the  ratio  of  silver  to  gold  was 
about  15£  to  1),  the  rupee  was  worth  23d.  in  English  money. 
At  the  lowest  price  which  silver  touched  until  1892  (40<i.  in 
that  year),  the  rupee  was  worth  only  15d.  In  1893,  when  the 
United  States  at  last  ceased  its  purchases  of  silver,  the  gov- 
ernment of  British  India  took  the  bold  step  of  closing  its  mints 
to  the  free  coinage  of  the  rupees.  Since  that  date,  the  rupee 
has  been  inconvertible  specie.  It  is  not  freely  coined,  and  its 
value  no  longer  fluctuates  with  that  of  silver  bullion.  The 
Indian  government  does  not  undertake  to  redeem  it  ill  gold, 
but  is  willing,  conversely,  to  give  rupees  for  gold  at  the  rate  of 
one  rupee  for  IQd.  in  gold.  Hence  the  rupee  cannot  be  worth 
more  than  16d.  in  gold.  The  hope  of  the  Indian  government 
was  to  make  it  Worth  as  much  as  IQd.,  and  thus  to  secure 
stability  in  the  gold  value  of  the  rupee.  That  hope  has  been 
fulfilled.  Though  there  Was  a  period  of  some  years  after 
1893  when  the  rupee  was  not  maintained  at  the  price  of  IQd., 
since  1898  this  has  been  accomplished.  The  limitation  of 
quantity  has  given  the  rupee  an  artificial  value,  just  as  limita- 
tion of  quantity  gives  paper  an  artificial  value.  The  bullion 
in  the  rupee  has  been  worth,  at  the  lowest  quoted  price  of  silver 
in  recent  years,  only  8d.  (in  1902),  or  one  half  of  the  value 
which  the  rupee  has  maintained  as  coin.  The  essential  cause  of 
this  maintenance  of  an  artificial  value  has  been  a  demand  for 
the  rupees  which  is  great  compared  to  their  limited  quantity.1 
An  interesting  case  of  a  similar  sort,  though  one  closely  con- 
nected with  inconvertible  paper,  is  that  of  Austria  from  1879  to 
about  1892.  Austria  had  paper  money  after  1848,  depreciated 
with  reference  to  specie.  By  specie  only  silver  was  meant ;  for 
Austria  had  had  a  silver  standard,  and  the  paper  gulden  (or 
florin,  as  it  was  often  called  in  English)  was  a  promise  to  pay 
a  gulden  in  silver.  The  depreciation  of  the  paper  during  the 
earlier  part  of  the  decade  1870-1880  was  roughly  10  per  cent. 
But  after  1873  silver  itself  began  to  depreciate,  gradually 

1  Since  1899  the  Indian  government  has  redeemed  the  rupee  in  gold  at  I6d., 
but  without  assuming  a  formal  obligation  to  do  so. 


GOVERNMENT  PAPER  MONEY  325 

dropping  toward  the  point  where,  in  terms  of  gold,  the  silver 
gulden  was  worth  no  more  than  the  paper  gulden.  In  1879, 
when  this  point  was  actually  reached,  silver  was  presented  at 
the  Austrian  mints  for  coinage,  because  it  was  profitable  to 
carry  bullion  to  the  mint,  and  to  use  the  silver  coin  in  Austria 
at  the  ruling  prices  of  goods.  Had  this  situation  continued, 
more  and  more  silver  would  have  found  its  way  into  Austria, 
paper  and  silver  would  have  circulated  side  by  side,  and  the 
paper  (whether  or  no  convertible  at  the  government  agencies 
into  silver)  would  have  been  worth  as  much  as  the  silver,  and 
no  more.  Prices  would  have  accommodated  themselves  to  the 
combined  quantity  of  the  two  sorts  of  money.  But  to  the 
Austrian  government  this  intrusion  of  silver  was  not  agreeable ; 
the  desirability  of  the  metal  was  in  question.  Accordingly,  in 
1879  it  stopped  the  free  coinage  of  silver.  Thereafter  the  cir- 
culating medium  consisted  in  part  of  inconvertible  paper,  but 
in  part  also  of  silver  gulden  coins,  of  which  some  had  been 
left  over  from  old  days,  some  had  been  struck  just  before  the 
suspension  of  1879.  Both  sorts  of  money  were  equally  legal 
tender;  they  circulated  side  by  side;  both  had  an  artificial 
value,  due  to  the  limitation  of  the  total  quantity.  The  silver 
gulden  coins  had  a  value  greater  than  that  of  the  silver  bullion 
contained  in  them.  No  better  illustration  could  be  found  of 
the  way  in  which  mere  limitation  of  quantity  maintains  the 
value  of  money. 

The  final  outcome  from  this  curious  situation  has  already 
been  indicated.  Austria  determined  to  go  over  to  the  gold 
standard,  and  adopted  a  new  coinage  system,  in  which  the 
crown  was  the  unit.  The  amount  of  gold  put  into  the  crown 
made  it  equal  to  one  half  the  market  value  of  the  existing 
paper  or  silver  gulden.  All  debts  payable  in  guldens  could 
be  liquidated  at  the  rate  of  two  crowns  for  each  gulden,  and 
the  guldens  were  to  be  gradually  replaced  by  coins  (and  paper 
convertible  into  coins)  of  the  crown  standard.  In  other  words, 
the  inconvertible  paper  and  silver  were  both  to  be  transformed 
into  gold-standard  money  at  the  existing  rate  of  depreciation, 


326  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

—  if  the  term  "  depreciation  "  can  be  accurately  applied  to  this 
peculiar  state  of  things.  The  process  of  change,  it  may  be 
remarked,  took  longer  in  Austria  than  had  been  expected,  and 
though  the  first  legislative  steps  were  taken  as  early  as  1892,  the 
plan  has  even  now  (1910)  not  been  completely  carried  out. 

§  6.  There  have  been  suggestions  or  dreams  of  international 
paper  money, — some  sort  of  universally  accepted  token  which 
should  circulate  between  nations  and  within  any  one  nation, 
should  be  regulated  in  quantity  and  presumably  in  value  on  a 
systematic  plan,  and  should  enable  specie  to  be  dispensed  with 
as  money.  Then  such  labor  as  mankind  would  still  devote  to 
mining  gold  and  silver  would  be  directed  solely  to  procuring 
them  for  use  in  the  arts.  That  labor  which  is  now  given  to 
procuring  the  bullion  used  as  money  would  be  set  free,  and 
money  would  be  got  in  the  much  cheaper  fashion  of  printing 
strips  of  paper. 

The  change  is  not  unthinkable,  and  it  appeals  to  those  who 
like  abstract  speculation  and  ideal  construction.  As  a  proposal 
of  anything  practicable,  it  is  not  worth  discussion.  The  nations 
of  the  earth  find  it  hard  to  come  to  agreement  on  much  simpler 
matters,  and  no  international  compact  of  this  sort  is  now  within 
the  range  of  possibility.  The  solid  basis  of  an  actual  physical 
scarcity,  of  a  high  cost  resulting  from  scarcity,  of  wide  general 
acceptability  and  serviceableness,  —  these  circumstances  under- 
lie the  universal  use  of  specie,  and  make  it  certain  that,  for  as 
long  a  time  as  we  can  consider  in  present  economic  arrange- 
ments, gold  and  silver,  and  mainly  gold,  will  be  the  basis  of 
the  world's  circulating  medium.  Gold  is  not  a  perfect  mone- 
tary medium,  but  it  is  the  best  which  the  fallibility  of  human 
nature  and  the  present  degree  of  civilization  enable  us  to  devise. 

§  7.  Convertible  government  paper  may  be  a  promise  to 
pay,  with  some  limited  stock  of  specie  provided  for  payments ; 
or  it  may  be  simply  a  certificate  of  deposit.  The  latter  is  per- 
haps hardly  government  paper ;  it  is  simply  a  device  for  facili- 
tating the  use  of  specie ;  yet  it  is  also  in  outward  form  a  promise 
to  pay. 


GOVERNMENT  PAPER  MONEY  327 

The  best  example,  and  in  modern  times  almost  the  only 
example  of  the  certificate  of  deposit,  is  found  in  the  familiar 
gold  and  silver  certificate  of  the  United  States.  For  every 
such  promise  to  pay  that  is  outstanding,  the  full  amount  of 
gold  or  silver  is  kept  in  the  vaults  of  the  United  States  Treasury. 
In  this  case  there  is  no  difference  whatever  between  the  paper 
and  the  specie,  except  in  the  convenience  of  handling.  The 
specie  simply  circulates  in  the  form  of  the  paper  substitute. 
For  silver  this  substitution  has  proved  of  great  importance. 
The  silver  dollars  are  bulky  and  inconvenient  when  carried  in 
quantities.  The  certificates  enable  the  silver  to  circulate 
much  more  freely  and  in  larger  volume  than  would  be  possible 
for  the  coins.  This  reason  for  resorting  to  certificates  does 
not  exist  for  gold  coins.  The  wide  use  of  gold  certificates  in 
the  United  States  is  due  partly  to  our  custom  of  not  redeem- 
ing worn  gold  coins  at  their  face  value,  partly  to  habit. 
Our  people  have  long  been  accustomed  to  paper  money. 
Throughout  the  earlier  part  of  the  nineteenth  century,  bank 
notes  were  the  chief  medium  for  everyday  purchases;  later, 
during  the  period  following  the  Civil  War,  inconvertible  paper 
completely  displaced  gold.  Although  specie  payments  were  re- 
sumed in  1879,  much  current  money  is  still  in  the  form  of 
paper,  such  as  the  bank  notes  and  the  United  States  notes; 
and  in  that  form  the  large  volume  of  silver  money  is  much 
more  convenient.  Purses  and  pocket  books  are  all  adapted 
to  paper  money,  hence  gold  certificates  are  usually  preferred 
to  gold  coin. 

Of  a  different  type  are  government  notes  proper,  these  being 
strict  promises  to  pay,  not  mere  certificates  of  deposits.  The 
most  conspicuous  example  of  this  sort  of  convertible  money 
is  again  in  this  country.  The  "United  States  notes"  just 
referred  to,  commonly  spoken  of  as  "greenbacks,"  are  reissues 
of  the  inconvertible  paper  issued  during  the  Civil  War.  When 
specie  payments  were  resumed,  these  notes  were  not  paid  off 
and  destroyed,  but  simply  made  convertible.  The  amount  then 
outstanding,  $346,000,000,  still  remains.  The  United  States 


328   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

Treasury  will  redeem  the  notes  on  demand  in  gold  coin ;  but  it 
does  not  reserve  dollar  for  dollar  toward  redeeming  them. 
Indeed,  for  many  years  after  1879,  no  special  supply  of  specie 
was  set  aside  to  redeem  them ;  they  were  simply  to  be  paid  out 
of  any  surplus  money  the  Treasury  happened  to  have  on  hand. 
In  1900  a  special  fund  of  $150,000,000  of  gold  was  created,  to 
be  held  solely  for  the  redemption  of  these  notes  when  presented, 
with  provisions  for  replenishing  the  fund  by  the  sale  of  gov- 
ernment bonds  in  case  it  should  be  depleted.  Since  that  date 
no  doubt  has  arisen,  and  none  is  likely  to  arise,  of  the  likeli- 
hood of  their  redemption  in  specie.  During  the  decade  preced- 
ing 1900,  there  had  been  on  several  occasions  serious  doubts; 
for  then  the  total  volume  of  paper  outstanding  (including  the 
silver  money)  was  very  large,  and  the  situation  was  so  dis- 
turbed as  to  lead  to  the  presentation  of  notes  for  gold.  Since 
1900  the  various  forms  of  paper  and  silver  money,  while  not 
absolutely  diminished,  have  become  less  as  compared  with  the 
extraordinary  increase  in  the  demand  for  money,  due  to  rapid 
growth  in  population  and  in  production.  The  United  States  notes, 
though  redeemable,  are  in  fact  rarely  presented  for  redemp- 
tion. They  circulate  side  by  side  with  gold,  are  a  complete 
legal  tender  for  debts,  are  sufficiently  limited  in  quantity,  and 
exert  in  every  respect  precisely  the  same  influence  on  prices  as 
would  the  same  quantity  of  gold  coin  or  gold  certificates. 

Essentially  similar  are  the  Reichskassenscheine  of  Germany, 
—  promissory  notes  of  the  German  Empire,  payable  on  demand. 
These  are  not,  like  our  United  States  notes,  a  legal  tender  for 
debts ;  but  they  are  receivable  at  par  in  all  pajinents  to  the 
empire  and  to  the  several  states.  No  special  fund  is  provided 
for  their  redemption.  But  the  issue  is  so  small  (only  120,000,000 
marks,  or  about  $30,000,000)  that  their  easy  circulation  side 
by  side  with  gold  is  assured.  The  Canadian  government  also 
has  outstanding  an  amount  of  convertible  notes  ($29,000,000) 
not  inconsiderable  for  that  country ;  they  are  legal  tender,  and 
are  protected  by  a  specified  reserve  of  gold. 

The  questions  of  principle  concerning  convertible  govern- 


GOVERNMENT  PAPER  MONEY  329 

ment  paper  are  simple.  So  long  as  convertibility  is  really 
maintained,  the  value  of  paper  necessarily  is  the  same  as  that 
of  specie.  Within  the  country  of  issue,  it  serves  as  money 
precisely  as  specie  does.  It  presents  none  of  the  peculiar 
questions  presented  by  inconvertible  paper.  It  can  affect  the 
general  range  of  prices  only  indirectly.  By  releasing  so  much 
specie,  and  presumably  causing  it  to  be  exported,  it  virtually 
adds  to  the  world's  stock  of  specie,  and  thereby  tends  to  raise 
the  world  level  of  prices;  and  this  tendency  will  affect  the 
issuing  country  as  well  as  other  countries.  An  effect  of  this 
sort,  it  is  obvious,  may  come  from  inconvertible  paper  also; 
for  that,  too,  in  driving  specie  out  of  the  country  of  issue,  in- 
creases by  so  much  the  total  amount  circulating  elsewhere  in 
the  world. 

More  complex  are  the  questions  of  expediency.  Govern- 
ment convertible  paper  is  a  dangerous  tool ;  not  so  dangerous 
as  inconvertible  paper,  yet  far  from  safe.  There  is  the  same 
difficulty  in  keeping  within  the  bounds  of  prudence.  A  small 
and  strictly  limited  issue,  like  that  of  Germany,  causes  no 
difficulties.  A  comparatively  large  one,  like  that  of  Canada, 
especially  when  combined  with  a  free  use  of  bank  notes  (as 
in  that  country)  causes  the  margin  of  specie  in  the  circulating 
medium  to  be  unduly  narrow.  In  the  United  States,  as  in 
Canada,  the  margin  of  gold  is  none  too  broad ;  for,  in  addition 
to  the  United  States  notes,  we  have  the  silver  certificates  and 
the  national  bank  notes,  all  depending  for  their  solidity  on  the 
concurrent  circulation  of  an  additional  quantity  of  gold.  It 
cannot  be  said  that  the  United  States  notes  now  are  a  serious 
source  of  danger ;  but  they  have  been  so  in  the  past,  and  they 
may  be  so  again  in  the  future. 

A  strong  objection  to  government  paper,  even  though  it  be  con- 
vertible, is  in  its  effect  on  the  morale  of  the  circulating  medium. 
It  is  a  mere  promise  to  pay ;  true,  one  that  it  is  proposed  to 
keep,  but  one  kept  at  the  will  of  the  debtor.  A  government 
cannot  be  sued  and  compelled  to  pay.  In  the  end,  the  creditor 
must  rely  simply  on  its  good  will.  Some  element  of  fiat  thus 


330        MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

attaches  necessarily  to  government  money.  On  the  other 
hand,  all  the  economies  and  advantages  from  the  use  of  paper 
money  can  be  secured  through  banks,  public  or  private.  These, 
being  not  the  state  itself,  but  agencies  of  the  state,  can  be  held 
to  their  obligations.  The  trend  in  all  the  advanced  countries 
is  toward  the  use  of  bank  notes,  not  of  government  paper,  as 
a  means  of  economizing  the  use  of  specie.  To  this  topic  we 
turn  in  the  chapters  to  follow. 


CHAPTER  24 
BANKING  AND  THE  MEDIUM  OF  EXCHANGE 

§  1.  Banks  perform  two  functions,  equally  important,  yet 
very  different.  They  act  as  agencies  for  the  collection  of 
savings  and  for  investment ;  they  create  a  part  of  the  medium 
of  exchange.  The  two  functions  are  often  performed  by  the 
same  institution,  but  not  infrequently  are  separated.  A 
savings  bank  has  to  do  with  investment  only;  and  this  is  the 
case  with  many  banks  of  Continental  Europe.  A  strictly  com- 
mercial bank  is  not  concerned  with  the  sort  of  "investment" 
to  which  the  term  is  commonly  limited,  —  that  which  looks  to 
the  creation  of  permanent  plant.  But  such  a  bank  supplies, 
in  English-speaking  communities  especially,  a  highly  important 
part  of  the  circulating  medium.  In  this  chapter  and  the  chap- 
ters following  we  shall  have  to  do  chiefly  with  the  monetary 
aspects  of  banking  operations. 

To  clear  away  preliminary  matters,  something  may  first  be 
said  of  those  banks  by  which  investment  operations  alone  are 
carried  on.  A  savings  bank  accepts  deposits ;  that  is,  it  receives 
sums  of  money  and  promises  to  repay  them.  The  promise  is 
usually  subject  to  conditions,  as,  for  example,  that  the  bank 
reserve  the  right  of  requiring  notice  (ten  days,  or  some  such 
period).  It  is  not  expected  that  the  depositor,  in  fact,  will  wish 
to  have  his  money  back  promptly.  Ordinarily  he  leaves  it 
with  the  bank  for  a  considerable  time,  and  expects  to  get 
interest  on  what  he  has  deposited.  The  operation  is  typical 
of  the  process  by  which  the  saving  of  money  leads  to  the  creation 
of  capital.  The  money  is  lent  commonly  to  persons  who  mean 
to  use  it  in  effective  investment,  as,  for  example,  in  erecting 
factories,  warehouses,  dwellings.  It  goes  into  circulation  again, 
and  repeats  its  rounds  in  performing  the  functions  of  the 

331 


332   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

medium  of  exchange.  But  it  has  been  meanwhile  the  instru- 
ment by  which  some  persons,  having  procured  the  command 
of  purchasing  power,  were  enabled  to  add  to  the  substantive 
capital  of  the  community.  Often  the  proximate  use  by  the 
savings  bank  is  in  the  purchase  of  securities ;  that  is,  of  promises 
to  pay,  or  certificates  of  ownership,  which  have  been  issued  by 
still  other  persons.  In  this  case  the  bank  is  but  one  link  in 
the  chain  which  connects  the  savers  of  money  with  the  makers 
of  capital,  The  same  process  of  collecting  surplus  means  and 
attending  to  their  investment  is  carried  on  by  government 
postal  savings  banks,  except  that  here  the  money  deposited  is 
commonly  used  in  buying  government  securities,  and  the  effect 
in  adding  to  the  real  capital  of  the  community  — -  its  apparatus 
of  production  —  is  more  doubtful.1 

Many  banking  institutions,  both  public  and  private,  are 
concerned  solely  or  mainly  with  such  operations.  The  bankers 
and  brokers  who  deal  in  so-called  investment  securities  act  as 
middlemen  for  the  prosperous,  just  as  the  savings  banks  do  for 
persons  of  smaller  means,  The  so-called  mortgage  banks  of 
Continental  Europe,  organized  as  public  or  semi-public  insti- 
tutions, perform  the  same  function.  Many  of  the  great  cor- 
porate banks  of  Germany,  France,  Austria,  systematically 
conduct  extensive  operations  in  placing  investments.  They 
accept  deposits  in  sums  large  or  small,  and  either  sell  securities 
directly  to  the  investor,  or  undertake,  as  does  a  savings  bank, 
to  pay  him  a  stipulated  rate  of  interest.  The  great  historic 
private  banking  houses  of  England  and  the  United  States,  and 
of  the  Continent  also,  —  the  Barings,  the  Morgans,  the  Roths- 
childs, and  their  numberless  rivals  and  associates  —  carry  on 
chiefly  investment  operations.  They  further  and  promote  new 
enterprises.  Commonly,  they  advance  largely  from  their  own 
means  in  the  early  stages  of  such  enterprises.  In  due  time, 
when  the  stage  of  settled  business  and  accruing  profits  has  been 
reached,  they  sell  the  enterprises  or,  more  often,  the  securities 
based  on  them,  to  the  saving  and  investing  public.  Each 

»  See  Book  I,  Chapter  5,  i  9. 


BANKING  AND  THE  MEDIUM  OF  EXCHANGE        333 

banking  house  of  this  sort  usually  has  its  circle  of  customers 
and  friends,  who  have  faith  in  its  judgment  and  honor,  and 
are  guided  by  its  advice. 

But  all  these  operations  have  little  to  do  with  monetary 
questions  proper.  It  is  the  operations  of  the  commercial 
banks  that  are  chiefly  associated  with  the  problems  of  money, 
—  banks  which  do  not  undertake  to  manage  permanent  in- 
vestments, but  to  lend  on  short  time  to  the  active  business 
community.  Such  banks  receive  deposits,  but  primarily  for 
the  convenience  of  the  depositor  in  the  safeguarding  of  cash, 
and  with  an  obligation  to  repay  at  any  time  on  demand  the 
whole  sum  deposited.  In  many  cases,  also,  such  banks  issue 
notes.  By  their  use  of  notes  and  of  deposits  they  affect  very 
greatly  the  medium  of  exchange. 

In  unfolding  this  subject,  the  same  method  will  be  followed 
as  in  preceding  chapters.  The  simplest  cases,  illustrating  the 
main  principles,  will  first  be  considered,  even  at  the  risk  of 
apparently  losing  touch  with  actual  conditions.  The  com- 
plications and  qualifications  will  then  be  introduced  step  by 
step. 

§  2.  The  simplest  operation  is  note  issue.  A  bank  note  is 
a  promise  to  pay  a  specified  sum  to  the  bearer  on  demand. 
In  law  it  is  like  any  other  promissory  note  payable  to  bearer. 
Title  to  it  passes  in  full  by  delivery,  and  each  successive  holder 
has  the  same  rights  against  the  bank.  If  the  institution  which 
issues  it  is  well  known,  the  note  may  pass  from  hand  to  hand 
for  an  indefinite  time,  and  perform  the  essential  functions  of 
money.  Even  if  the  institution  is  not  well  known,  the  note 
may  remain  long  in  circulation  if  people  have  become  accus- 
tomed to  the  use  of  such  paper  substitutes,  and  if  there  is  no 
special  ground  for  distrusting  the  particular  bank  that  issues 
it.  Money  is  to  a  very  great  degree  a  matter  of  custom ; 
what  one  person  offers  in  payment,  and  the  next  person  is 
likely  to  accept  in  payment,  passes  readily  from  hand  to  hand. 
Experience  has  amply  proved  that  not  only  notes  issued  by 
responsible  institutions,  but  notes  issued  by  others  that  assume 


334        MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

the  outward  show  of  responsibility,  pass  into  the  channels  of 
circulation  with  surprising  ease. 

The  bank,  none  the  less,  is  under  a  strict  legal  obligation  to 
pay  every  note,  whenever  presented,  in  that  money  which  is 
legal  tender  for  debts  in  general.  We  may  assume  specie,  or 
gold,  to  be  the  only  legal  tender.  The  bank  must  keep  at  all 
times  some  gold  wherewith  to  repay  (or,  as  it  is  said,  redeem) 
notes  that  are  presented.  If  it  keeps  just  as  much  specie  as  it 
has  notes  outstanding,  its  note  issue  obviously  can  be  no  source 
of  profit;  for  the  expense  of  printing  the  notes  and  of  main- 
taining the  bank  office  there  is  no  compensation.  But  if  it 
keeps  less  gold  than  the  notes  outstanding,  there  is  the  chance 
of  profit.  The  excess  of  notes  issued  over  and  above  the  specie 
kept  on  hand  is  often  called  the  "uncovered"  issue.  The  larger 
the  uncovered  issue,  the  greater  the  opportunity  for  gain. 
Every  bank  which  is  left  to  follow  its  course  without  legislative 
restriction,  tends  to  keep  as  little  specie  as  possible,  and  to 
have  as  large  an  uncovered  issue  as  possible. 

The  more  secure  a  bank  note  is,  —  the  more  certain  is  pay- 
ment in  full  whenever  demand  is  made,  —  the  less  probably 
will  notes  in  fact  be  presented  for  payment.  They  are  then 
likely  to  circulate  continuously  as  money.  This  condition  is 
virtually  reached  under  most  modern  legislation  upon  bank 
notes.  They  are  usually  issued  (as  will  be  more  fully  explained 
below)  either  by  great  public  institutions  or  by  private  banks 
held  to  infallible  payment.  Consequently,  the  holder  has  no 
inducement  to  present  them,  and  the  bank  is  under  no  pressure 
from  him  to  maintain  a  fund  for  their  redemption.  It  has 
followed,  as  a  further  consequence,  that  additional  legislation, 
or  custom  equivalent  in  binding  force  to  legislation,  is  needed 
in  order  that  there  shall  be  kept  on  hand  a  considerable  supply 
of  specie  for  note  redemption. 

Bank  notes  thus  take  the  place  of  specie  very  much  as  in- 
convertible paper  does.  An  extreme  case  may  even  be  imagined 
in  which  they  would  entirely  displace  specie.  That  extreme 
can  never  be  reached,  so  long  as  the  banks  are  held  to  their 


BANKING  AND  THE  MEDIUM  OF  EXCHANGE       335 

obligation  to  pay  on  demand.  Some  specie  must  always  be 
kept.  But  where  banks  are  allowed  to  issue  without  restraint, 
a  near  approach  to  the  extreme  may  be  reached.  So  it  was  in 
the  United  States  before  1860,  when  a  multitude  of  banks, 
chartered  by  the  several  states,  issued  notes,  and  each  was 
under  the  temptation  to  put  out  its  notes  as  freely  as  possible. 
The  everyday  circulating  medium  consisted  of  these  notes, 
and  only  a  narrow  margin  of  specie  was  held  in  the  bank  vaults. 
In  some  parts  of  the  country,  especially  in  what  were  then  the 
new  regions  of  the  West  (Illinois  and  Wisconsin,  for  example), 
redemption  of  the  notes  in  specie  was  not  insisted  on  by  law 
and  business  custom,  and  they  were  virtually  inconvertible 
paper.  In  New  England,  New  York,  and  the  Eastern  seaboard 
generally,  and  in  Ohio  and  Indiana,  the  notes  were  really  con- 
vertible into  specie,  yet  their  specie  basis  was  small  as  com- 
pared with  all  the  demand  obligations  of  the  banks. 

A  simple  and  effective  device  for  preventing  bank  notes, 
even  though  freely  issued,  from  completely  displacing-  specie,  is  to 
prohibit  notes  of  small  denominations.  This  is  now  the  com- 
mon practise  in  European  countries.  Bank  of  England  notes 
cannot  be  issued  under  five  pounds,  Bank  of  France  notes 
under  fifty  francs,  German  bank  notes  under  twenty  marks.1 
Where  this  is  done,  and  where  no  other  form  of  paper  is  issued 
in  small  denominations,  a  considerable  circulation  of  specie  is 
assured.  If  the  banks  were  to  issue  an  undue  quantity  of 
large  notes,  and  if  these  were  to  displace  specie,  people  would 
feel  inconvenience  from  a  lack  of  money  fitted  for  everyday 
minor  transactions,  and  would  present  the  large  notes  at  the 
banks'  counters,  not  necessarily  from  any  sense  of  uneasiness,  or 
from  any  wish  to  enforce  redemption,  but  simply  for  the  con- 
venience of  having  the  notes  "broken"  into  convenient  denomi- 
nations. If  the  banks  can  issue  small  notes,  this  demand  will 
of  course  be  satisfied  without  resort  to  specie ;  and  then  it  is 

1  Both  the  German  and  the  French  notes  of  the  smaller  denominations  are 
in  fact  issued  sparingly,  with  the  express  design  of  preventing  the  displace- 
ment of  specie. 


336        MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

possible  that  bank  notes  will  almost  entirely  displace  specie. 
This  was  the  common  situation  in  the  United  States  before 
the  Civil  War,  when  almost  all  of  the  states  permitted  small 
issues,  and  the  everyday  circulation  was  made  up  almost 
wholly  of  bank  notes.  Under  the  national  banking  system, 
banks  may  not  issue  notes  in  smaller  denominations  than 
$5,  and  recent  legislation  (of  1900)  has  provided  that  only  one 
third  of  their  issues  can  be  in  notes  of  this  amount.1  But 
restriction  of  this  sort  achieves  little  so  long  as  the  government 
itself  issues  notes  of  small  denominations,  as  our  government 
does  with  its  own  convertible  notes  (greenbacks)  and  its  over- 
valued silver  dollars  and  certificates.  A  substantial  gain  from 
such  legislation  is  secured  only  when  its  effect  is  to  bring  about 
a  large  circulation  of  full-value  specie,  —  that  is,  of  gold. 

§  3.  In  modern  times,  especially  in  English-speaking  coun- 
tries, notes  do  not  stand  alone.  Beside  them,  and  of  much 
greater  volume  and  effect  in  a  country  like  the  United  States,  are 
the  deposits.  Though  there  are  important  differences  between 
notes  and  deposits,  as  will  appear  presently,  a  fundamental 
similarity  exists,  long  noted  by  careful  observers,  yet  little 
understood  by  many  writers  on  banking,  and,  oddly  enough, 
often  not  understood  by  the  very  bankers  concerned  with  the 
daily  management  of  notes  and  deposits. 

Most  persons  think  of  a  deposit  as  cash  left  with  a  bank. 
This  the  word  signifies;  and  this  the  transaction  originally 
was.  Historically,  deposits  began  as  specie  left  with  trusted 
persons.  This  was  the  case  with  the  bankers  of  Venice  and 
Florence  in  the  early  period  of  the  Renaissance,  and  with  the 
goldsmiths  of  London  during  the  second  half  of  the  seventeenth 
century.  Where  the  banker  or  goldsmith  kept  intact  the  specie 
so  left,  he  evidently  made  no  gain;  nay,  he  would  probably 
demand  a  fee  from  the  depositor  for  the  care  of  the  gold  or 
silver.  When  next  a  depositor  had  a  payment  to  make,  it 

1  Until  the  resumption  of  specie  payments  in  1879,  national  banks  were  al- 
lowed to  have  one  sixth  of  their  notes  in  denominations  of  less  than  $5.  There 
was  no  occasion  for  restricting  them  so  long  as  specie  did  not  circulate  in  any 
case. 


was  a  natural  process  to  give  to  the  payee  an  order  on  the 
banker,  or  to  deliver  to  him  the  banker's  receipt.  It  was  an 
equally  natural  process  for  this  third  person,  if  he  had  no  im- 
mediate need  of  the  money,  to  continue  to  leave  it  in  the  banker's 
charge,  simply  getting  another  receipt  or  having  his  name 
inscribed,  instead  of  hia  debtor's,  on  the  banker's  records  as  a 
depositor-  If  many  persons  did  this,  having  faith  in  the 
banker's  honesty  and  solidity,  he  might  use  part  of  the  specie 
in  his  own  ventures,  or  lend  it  out  to  others.  In  the  earliest 
times,  the  persons  to  whom  such  deposits  were  intrusted  were 
commonly  engaged  in  active  business,  and  they  Used  the  funds 
in  their  current  operations.  Later,  they  developed  the  safer 
practise  of  lending  the  funds,  on  short  time  and  on  good 
security.  Only  as  they  so  became  systematic  lenders,  did  they 
come  to  be  bankers  in  the  modern  sense.  Specie  was  then 
kept  on  hand  merely  in  such  quantities  as  were  supposed 
necessary  to  meet  the  demands  of  persons  actually  calling  for 
it ;  and  the  deposits  became  a  source  of  profit. 

This  sort  of  depositing  still  plays  a  considerable  part  in  con- 
temporary banking  operations.  In  the  United  States  and 
England,  many  persons  keep  bank  accounts  merely  for  the 
convenience  of  not  handling  and  safeguarding  large  sums  of 
cash.  Such  are  salaried  persons,  and  those  of  the  leisure  class 
who  have  considerable  means.  These  take  to  the  bank  and 
deposit  at  once  whatever  money  or  rights  to  money  may  dome 
into  their  hands,  making  most  payments  by  checks  on  the 
bank  and  drawing  cash  only  for  petty  expenses.  They  ha- 
bitually leave  most  of  their  current  funds  on  deposit.  The 
banker  knows  by  experience  that  only  a  certain  fraction  (and 
a  surprisingly  small  fraction)  will  be  called  for  at  any  one  time, 
A  very  great  part  of  what  is  deposited  can  be  lent  out  again  by 
him  for  profit. 

But  the  larger  part  of  the  deposits  in  the  commercial  banks 
of  a  country  like  the  United  States  or  England  do  not  arise  in 
this  way.  The  deposits  are  in  the  main  created  by  these  banks. 

It  is  easy  to  see  in  what  manner  bank  notes  are  created, 
z 


338   MONEY  AND  THE  MECHANISM  'OF  EXCHANGE 

A  bank's  main  business  is  to  lend,  and  to  lend  not  its  money 
or  its  capital,  but  its  credit.  This  is  what  it  does  when  it  puts 
out  bank  notes.  We  usually  say  that  a  bank  "issues"  its 
notes.  In  fact,  it  lends  them.  It  turns  over  to  the  borrower 
instruments  which  he  can  use  in  purchases,  and  these  instru- 
ments circulate  because  the  credit  of  the  bank  is  good.  The 
bank  lends  him,  in  other  words,  its  credit,  which  in  that  form 
serves  as  well  as  money. 

Essentially  the  same  thing  is  done  when  a  bank  lends  in  the 
form  of  a  deposit.  The  common  and  typical  operation  is  that 
of  the  discount  of  a  note.  The  borrower  brings  to  the  bank 
his  promissory  note,  perhaps  signed  only  by  himself,  perhaps 
fortified  by  the  indorsement  (i.e.  guarantee)  of  others.  The 
bank  then  credits  him  with  a  "deposit"  of  the  amount  of  hi:: 
note,  less  the  agreed  interest.1  He  has  the  right  to  draw  on 
the  bank  as  if  he  had  actually  deposited  money.  That  right 
he  may  exercise  either  by  demanding  cash  directly  at  its  counters, 
or  (more  probably)  through  a  check,  which  directs  the  bank  to 
make  payments  to  others.  The  first  step  in  the  ordinary  com- 
mercial loan  is  the  creation  of  such  a  depositor's  relation  with 
the  bank. 

But  it  is  obvious  that  this  first  step  will  have  no  special 
consequences  if  the  depositor  exercises  his  right  at  once.  If 
he  draws  out  immediately  the  full  amount  credited  to  him,  the 
result  is  the  same  as  if  he  had  carried  off  cash  without  the  in- 
termediate step.  And  it  may  appear  that  this  is  what  he  is 
likely  to  do ;  for  he  borrows  with  the  purpose  of  using  money 
means  in  business  operations.  But  any  depositor  who  did 
this,  and  who  had  no  other  relation  with  the  bank,  would  be 
an  unprofitable  customer,  and  not  one  to  whom  the  bank 
would  habitually  extend  "accommodation."  All  banks,  and 

1  The  interest  in  case  of  bank  discount  is  usually  calculated  on  the  face  of  the 
note,  not  on  the  amount  lent  or  credited.  Thus  if  a  note  for  $1000  is  discounted 
for  three  months  at  6  per  cent,  the  interest  (11  per  cent  for  the  quarter  year) 
is  calculated  on  the  $1000,  and  the  depositor  is  credited  with  $985.  When  the 
discount  proceeds  in  this  way  at  6  per  cent,  the  borrower  in  fact  pays  a  slightly 
higher  rate  of  interest  on  the  amount  lent  to  him  or  put  to  his  credit. 


BANKING  AND  THE  MEDIUM  OF  EXCHANGE        339 

especially  the  commercial  banks  of  deposit,  deal  chiefly  with 
their  own  circle  of  customers.  These  are  both  borrowers  and 
depositors,  both  creditors  and  debtors.  They  keep  their 
account  with  the  bank,  and  there  is  a  tacit  understanding, 
not  infrequently  an  explicit  bargain,  that  the  amount  of  loan 
accommodation  extended  to  them  shall  be  in  proportion  to  the 
balance  which  is  on  the  average  to  their  credit  as  depositors. 

It  is  possible,  even  probable,  that  very  soon  after  a  loan  is 
made,  the  borrower  will  draw  heavily  against  it.  He  is  not 
likely  to  draw  out  the  full  amount ;  for  every  man,  and  especially 
every  business  man,  wishes  to  keep  some  balance  at  the  bank  as 
a  reserve  for  contingencies.  But  even  if  he  draws  out  the  larger 
part,  his  bank  balance  does  not  long  remain  depleted.  Payments 
to  him  from  his  customers  and  debtors  flow  in  from  day  to  day, 
and  are  deposited  in  the  bank  as  they  come  in.  Meanwhile,  as 
the  days  and  weeks  pass,  he  must  prepare  for  the  maturity  of 
the  note  with  which  the  transaction  began.  He  does  so  by  accu- 
mulating deposits,  and  toward  the  end  of  the  period  during 
which  the  note  runs  he  has  larger  amounts  to  his  credit.  When 
his  note  becomes  due,  he  pays  it  by  drawing  against  the  accu- 
mulated deposits ;  that  is,  essentially  he  offsets  the  debt  which 
he  owes  on  his  note  against  the  debt  which  the  bank  owes  him 
on  deposit  account.  Therewith  the  transaction  is  wound  up. 

But  this  transaction  does  not  stand  alone,  and  this  business 
man  does  not  stand  alone.  He  will  resort  to  the  bank  again  for 
loans,  and  others  will  also  resort  to  it ;  for  all  men  in  active  busi- 
ness are  borrowers,  in  order  to  carry  on  their  operations  con- 
tinuously and  on  a  larger  scale  than  their  own  means  permit. 
Their  transactions  with  the  banks  are  repeated  in  an  endless 
series.  Suppose  now  that  a  number  of  such  persons  are  dealing 
with  a  bank  as  borrowers  and  depositors.  While  some  are  dis- 
counting and  are  drawing  heavily  on  the  deposits  created  for 
them,  others  are  preparing  to  meet  their  maturing  notes  and  are 
depositing  heavily.  Some  happen  to  have  made  large  payments 
in  the  ordinary  course  of  business,  and  their  deposits  are  scant  ; 
others  have  been  receiving  large  payments,  and  their  deposits  are 


heavy.  At  any  given  time,  the  bank  has  a  volume  of  deposits, 
large  or  small  according  to  the  business  it  has  built  up,  and  has 
corresponding  resources  in  the  way  of  notes  discounted,  Prob- 
ably it  has  also  some  deposits  of  the  non-business  kind,  inde- 
pendent of  its  lending  operations ;  and  probably  it  has  also  some 
loans  not  related  to  its  deposits.  But  it  has  continuously  a 
volume  of  resources  (debts  to  it)  closely  related  to  a  correspond- 
ing volume  of  deposits  (debts  due  by  it), 
'  These  continuing  deposits  are  like  money ;  or,  to  be  more  ac- 
curate, they  are  essentially  like  bank  notes,  and  they  serve  as 
part  of  the  medium  of  exchange  just  as  any  other  circulating 
medium  does.  It  may  seem  odd  to  speak  of  a  deposit  as  part  of 
the  circulating  medium.  Most  persons  would  accede  to  the 
statement  that  a  check  serves  to  effect  payments  as  well  as  does 
a  gold  coin  or  a  paper  note ;  but  they  would  say  that  the  check, 
not  the  deposit,  is  the  equivalent  of  money,  Yet  a  moment's 
reflection  will  show  that  the  check  bears  the  same  relation  to 
the  deposit  which  the  coin  used  in  making  payments  bears  to  the 
coin  carried  in  the  pocket.  Not  all  the  coin  (taking  coin  as 
typical  of  the  money  that  passes  from  hand  to  hand  by  de- 
livery) is  buying  commodities  all  the  time.  Part  of  it  is  carried 
in  pockets  or  kept  in  tills,  by  way  of  reserve,  to  be  used  at 
convenience.  The  portion  of  it  actually  used  in  purchases  is 
determined  by  what  we  have  called  the  rapidity  of  circulation  of 
the  money.  Deposits  similarly  are  a  reserve,  a  potential  means 
of  payment,  drawn  upon  at  convenience,  Just  as,  in  reckon- 
ing the  total  quantity  of  specie  in  a  community,  we  count  the 
whole  supply  on  hand,  not  merely  that  which  happens  to  be 
making  purchases  at  a  given  moment ;  so,  in  reckoning  this  form 
of  the  circulating  medium,  we  must  count  up  the  total  volume 
of  deposits,  not  that  part  which  happens  to  be  in  immediate  use 
in  the  form  of  checks.  The  check  is  simply  the  deposit  in  actual 
use,  and  the  proportion  of  checks  to  deposits  represents  the 
rapidity  of  circulation  of  deposits. 

Rapidity  of  circulation  is  high,  in  the  case  of  commercial  banks 
and  business  men's  deposits.    Checks  are  drawn  against  such  de~ 


BANKING   AND  THE  MEDIUM   OF  EXCHANGE        341 

posits  daily,  and  fresh  deposits  are  made  daily.  In  the  language 
of  the  commercial  world,  these  are  "active"  accounts;  their 
turnover  is  rapid.  The  deposits  of  persons  of  the  leisure  class 
are  much  less  active.  Coin  and  everyday  pocket  money  — 
whether  coin  or  bank  notes  or  government  paper  —  probably 
have  in  all  cases  a  much  less  rapidity  of  circulation  than  a  com- 
mercial bank's  deposits. 

§  4.  All  use  of  money  could  be  done  away  with,  if  there  were 
but  a  single  bank,  if  all  deposits  were  kept  at  it  alone,  and  if  all 
payments  were  made  by  checks  on  it.  The  payee  of  a 
check  ordinarily  "deposits"  it.  Thereupon  this  single  bank 
would  deduct  so  much  from  the  amount  credited  to  him  who 
drew  the  check,  and  add  so  much  to  the  amount  credited  to  the 
payee.  No  money  would  pass,  and  the  payments  would  be 
effected  simply  by  substituting  one  person  for  another  as  the 
bank's  creditor  (i.e.  depositor). 

Suppose  now  that  there  are  two  banks,  having  different  sets 
of  customers.  Some  customers  and  depositors  of  bank  A  will 
draw  checks  payable  to  those  of  bank  B ;  and  on  the  other  hand 
customers  and  depositors  of  bank  B  will  draw  checks  payable  to 
those  of  bank  A.  Each  bank  will  receive  daily  checks  drawn 
on  the  other  bank,  deposited  with  it  for  collection.  The  banks 
can  readily  offset  claims,  and  arrange  to  pay  only  such  differences 
as  may  be  due  to  one  or  the  other.  It  is  conceivable  that  they 
may  even  arrange  not  to  pay  the  differences  at  all,  but  to  keep  a 
running  account,  the  balance  being  one  day  in  favor  of  bank  A, 
the  next  in  favor  of  bank  B,  with  a  tendency  to  equalization  in 
the  end.  At  all  events,  the  amount  of  specie  or  money  that  will 
have  to  pass  between  them  from  time  to  time  will  be  small  as 
compared  with  the  transactions  concluded  by  mere  offsetting. 

Next,  instead  of  two  banks,  imagine  a  dozen,  twenty,  any 
number ;  the  same  process  can  be  carried  on.  Daily  each  bank 
receives  checks  drawn  against  the  other  banks.  Daily  each  has 
to  meet  the  checks  drawn  by  its  own  customers,  and  deposited 
by  the  several  payees  with  the  other  banks.  Though  a  few  checks 
may  be  disposed  of  within  each  bank  (when  the  payee  happens 


342   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

to  keep  his  account  in  the  same  bank  as  the  drawer),  most  of 
thera  are  not  settled  quite  so  easily.  Yet  they  are  disposed  of 
in  practically  the  same  way.  They  go  through  the  clearing 
house,  where  the  process  of  offsetting  checks  against  each  other 
is  carried  to  its  farthest  limits. 

A  clearing  house  is  a  general  organization  of  the  banks  of  a 
given  place,  having  for  its  main  purpose  the  offsetting  of  cross 
obligations  in  the  form  of  checks.  Every  bank  sends  to  the 
clearing  house  all  checks  it  has  received  against  other  banks,  and 
each  has  to  meet  the  checks  drawn  against  it.  The  totals,  of 
course,  exactly  offset  each  other.  Any  one  bank  may  have  a 
debit  or  a  credit  balance,  and  is  in  strictness  bound  to  pay  in 
cash,  or  entitled  to  receive  in  cash,  the  balance  due.  In  practise, 
the  balances  are  often  settled  in  other  ways.  Sometimes  they 
are  paid  by  checks  on  another  large  bank.  In  London,  clearing- 
house balances  are  settled  by  checks  on  the  Bank  of  England, 
with  which  each  of  the  associated  banks  keeps  a  deposit  ac- 
count ;  and  then  all  the  payments  are  finally  effected  by  mere 
offsetting,  without  the  use  of  any  cash  at  all.  In  the  interior 
parts  of  the  United  States,  clearing-house  balances  are  often 
settled  in  New  York  exchange;  that  is,  by  checks  (commonly 
called  "  drafts,"  when  drawn  by  one  bank  on  another)  on 
large  banks  in  New  York,  with  one  or  another  of  which  each  in- 
terior bank  keeps  an  account.  The  final  settlement  of  the  trans- 
actions then  takes  place  through  the  New  York  clearing  house, 
with  a  minimum  use  of  cash.  Sometimes  clearing-house  bal- 
ances are  simply  left  to  go  from  day  to  day,  as  debts  due  by  one 
bank  to  another,  subject  to  payments  of  interest  by  the  debtor 
bank.  A  bank  which  is  debtor  at  the  clearing  house  one  day 
may  expect  to  be  creditor  another  day,  and,  unless  it  happsns  to 
have  an  unusual  supply  of  cash  in  its  own  coffers,  may  let  any 
daily  balance  against  it  stand  as  a  debt  due  the  creditor  banks. 
This  practise  of  course  depends  on  the  willingness  of  the  cred- 
itor banks  to  let  the  debt  stand,  and  also  upon  the  rules  agreed 
on  by  the  banks  in  general  for  clearing-house  operations.  The 
healthier  practise  is  to  maintain  payments  of  balances  in  cash 


BANKING  AND  THE  MEDIUM  OF  EXCHANGE        343 

once  for  all;  but  the  same  reasons  which  induce  all  deposit 
banks  to  reduce  their  cash  to  the  minimum  lead  them  to  miti- 
gate by  postponement  the  strict  obligation  to  settle  clearing- 
house balances  in  cash. 

At  all  events,  most  of  the  checks  are  disposed  of  by  being  bal- 
anced against  each  other.  The  larger  the  banks,  and  the  greater 
their  number,  the  more  likely  it  is  that  any  one  will  have  at  the 
clearing  house  about  as  much  to  its  credit  as  to  its  debit.  In  a 
comparatively  small  city  it  is  more  likely  that  the  offsetting  will 
not  be  complete,  and  that  any  one  bank  will  have  a  considerable 
balance  in  proportion  to  the  total  transactions  to  receive  or  pay. 
In  a  large  city  the  off  setting  process  is  achieved  with  extraordinary 
completeness.  In  New  York  and  London  95  per  cent  or  more  of 
the  clearing  house  exchanges  are  settled  by  offset,  and  the  bal- 
ances payable  and  receivable  by  individual  banks  amount  to  less 
than  5  per  cent  of  the  total.  Practically  the  same  proportion  is 
found  in  cities  like  Philadelphia,  Boston,  Chicago,  Liverpool,  and 
Manchester. 

Clearing  houses  develop  pan  passu  with  deposit  banking. 
Deposit  banking,  again,  has  developed  most  in  English-speaking 
countries,  and  most  of  all  in  the  United  States.  The  London 
clearing  house  was  established  in  1775 ;  this  early  date  is  con- 
clusive proof  that  deposit  banking  was  then  carried  on  in  large 
volume  by  a  considerable  number  of  banks.  The  New  York 
clearing  house  was  established  in  1853 ;  a  date  somewhat  late  in 
view  of  the  early  and  rapid  development  of  deposit  banking  in 
New  York.  Every  considerable  city  in  the  United  States  now 
has  its  clearing  house,  and  not  a  few  cities  that  are  inconsidera- 
ble. In  1908  there  were  115  cities  having  clearing  houses. 

§  5.  Deposits  in  their  operation  as  a  circulating  medium  are 
among  the  most  marvelous  of  economic  phenomena.  Like  the 
division  of  labor  which  they  serve  to  facilitate,  they  have  de- 
veloped by  no  intention,  and  have  had  little  restraint  or  guidance 
from  legislation.  They  work  out  their  results  by  processes  which 
are  but  half  understood  by  the  very  persons  who  manage  them. 
In  countries  where  deposit  banking  is  largely  resorted  to,  like 


344        MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

England  and  the  United  States,  all  wholesale  transactions,  and  a 
large  and  growing  volume  of  retail  transactions,  are  carried  on  by 
them.  They  combine  in  a  remarkable  degree  safety  and  con- 
venience. They  are  safe  because  a  check  is  payable  to  a  speci- 
fied person,  and  the  bank  is  answerable  for  making  payment 
to  that  person  only  or  to  his  endorsee.1  They  are  convenient 
because  a  few  strokes  of  the  pen  serve  to  remit  any  sum,  however 
large,  and  to  remit  that  sum  precisely  to  the  last  cent.  The 
mechanism  is  wonderfully  smooth  in  its  working,  and  effective. 

Two  things  are  essential  for  the  development  of  deposit  bank- 
ing ;  or  rather  two  phases  of  one  thing,  —  confidence.  Checks 
cannot  pass  from  one  person  to  another  unless  there  is  confidence 
in  the  probity  of  the  drawer.  Business  custom  has  supplied  sub- 
stantial ground  for  this  confidence.  Quite  apart  from  criminal 
penalty,  he  who  draws  a  check  without  having  credits  at  the 
bank  to  meet  it  commits  industrial  suicide.  More  important 
is  confidence  in  the  bank  itself.  The  basis  of  the  entire  system 
is  the  repute  and  good  standing  of  the  bank.  It  can  endure, 
for  any  individual  bank,  or  for  the  banks  as  a  whole,  only  so 
long  as  people  think  the  bank's  obligation  to  pay  money  to  be 
equally  good  with  the  money  itself.  For  the  highest  develop- 
ment of  the  system,  moreover,  it  seems  to  be  necessary  that  the 
custom  of  loans  through  deposits  —  the  creation  of  deposits  — • 
should  be  widespread ;  for  this  is  essential  to  the  greatest  quanti- 
tative growth. 

Given  these  conditions,  the  vast  but  frail  mechanism  main- 
tains itself  in  unceasing  round :  loans  are  made,  deposits  created, 
checks  drawn,  deposits  maintained,  loans  again  made,  and  so  on. 
It  consists  of  a  mere  mass  of  debts,  contracted  without  any  for- 
mality, and  evidenced  only  by  a  few  figures  on  bank  ledgers  and 
pass  books.  It  is  a  sort  of  phantom  circulating  medium,  ever 
appearing  and  disappearing,  never  substantial,  always  in  danger 

1  In  England,  checks  are  commonly  "crossed."  The  drawer  writes  across 
the  face  the  name  of  the  payee's  bank  ;  or  else  he  crosses  in  blank,  simply  draw- 
ing two  lines  across  the  check.  The  check  then  becomes  payable  only  if  pre- 
sented through  some  bank.  Experience  in  the  United  States,  where  checks  are 
not  crossed,  indicates  that  this  precaution  against  fraud,  though  useful,  is  not 
indispensable. 


of  melting  away  from  a  breath  of  suspicion,  yet  so  serviceable 
as  to  be  renewed  after  every  collapse  and  to  be  maintained 
notwithstanding  every  danger. 

§  6.  The  wide  use  of  deposits  has  important  effects  on  the 
rest  of  the  circulating  medium,  and  therefore  on  the  mode  in 
which  notes  are  dealt  with  by  the  banks. 

A  bank's  liability  for  ita  deposits  is  more  likely  to  be  forced 
upon  its  attention  than  that  for  notes.  Both  are  alike  demand 
obligations.  But  the  note,  which  passes  from  hand  to  hand  by 
delivery,  may  remain  outstanding  a  long  time,  and  its  presenta- 
tion for  redemption  may  become  almost  a  remote  contingency. 
On  the  other  hand,  when  a  deposit  goes  into  active  circulation, 
—  that  is,  when  a  check  is  drawn,  —  the  bank  is  likely  soon  to 
hear  from  it.  True,  a  check  may  read  "  Pay  to  the  bearer  "  and  so 
may  pass  from  hand  to  hand  by  delivery,  like  a  note;  but 
such  checks  are  little  used,  if  for  no  other  reason  than  that  they 
lack  safety  for  transmission.  Again,  a  check  may  be  indorsed 
by  the  payee  to  another  person,  by  him  may  be  further  indorsed 
to  still  others,  and  so  again  and  again.  In  each  transfer  it  may 
serve  to  effect  payments  as  well  as  a  bank  note  or  a  coin.  But 
this  Use  of  checks  is  also  of  no  considerable  consequence ;  since 
the  precise  sum  for  which  a  check  is  drawn  is  not  likely  to  be 
wanted  in  a  number  of  successive  transactions.  As  a  rule  a 
check  soon  travels  back  to  the  bank  on  which  it  is  drawn,  com- 
monly via  another  bank  and  through  the  clearing  house.  Thus 
the  demand  obligations  of  the  deposit  has  constantly  to  be  faced. 
This,  obviously,  is  the  case  especially  with  the  active  deposits  of 
commercial  banks. 

Against  the  steady  presentation  of  checks  a  bank  has  the 
funds  which  are  steadily  being  put  into  its  care  by  its  customers, 
—•that  is,  the  checks  on  other  banks  and  the  spare  cash  deposited 
with  it.  The  maintenance  of  its  unfailing  volume  of  resources 
depends  on  that  foundation  of  confidence  just  described, — the 
habitual  putting  in  its  charge  of  all  free  resources  not  needed 
by  its  customers  for  immediate  payments.  Given  this,  and  it 
cannot  only  create  deposits,  but  maintain  them  by  constant 


346   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

renewal ;  always  subject,  however,  to  a  daily  presentation  of 
demands  against  deposits. 

When,  however,  the  use  of  banks  as  repositories  of  all  spare 
funds,  and  so  the  use  of  deposits  as  currency,  has  become  highly 
developed,  the  rest  of  the  circulating  medium  becomes  involved 
in  the  all-pervading  operations  of  the  banks.  "Cash"  or 
"money,"  —  including  bank  notes  and  government  notes,  such 
as  pass  by  mere  delivery,  —  all  this  comes  to  be  used  chiefly  in 
retail  transactions.  When  so  used  it  is  likely  to  find  its  way 
regularly  to  the  bank  counters,  since  most  retail  dealers  keep  a 
bank  account,  and  send  in  their  daily  receipts  for  deposit.  The 
cash  is  drawn  out  again  by  an  entirely  different  set  of  persons : 
by  other  merchants,  by  employers  for  use  in  pay  rolls,  and  by  all 
depositors  for  pocket-money  use.  Hence  cash  is  constantly 
passing  in  and  out  of  the  banks. 

This  situation,  for  example,  has  an  influence  on  the  mode  of 
circulation  of  bank  notes.  When  the  note  is  the  only  form  of 
bank  currency,  it  may  remain  afloat  a  considerable  time  without 
being  presented  at  the  bank  of  issue.  But  when  notes  and  de- 
posits are  freely  used  side  by  side,  the  notes  are  constantly  get- 
ting into  the  hands  of  some  bank  or  other.  To  the  receiving  bank 
two  courses  are  then  open.  It  may  pay  the  note  out  again  over 
its  counter,  indiscriminately  with  other  cash ;  or  it  may  send  it 
for  redemption,  like  a  check,  to  the  bank  of  issue.  The  former 
course  is  likely  to  be  adopted  where  the  notes  have  been  issued 
by  a  great  public  bank,  or,  as  in  the  case  of  our  national  bank 
notes,  by  private  banks  held  to  very  rigid  limitations  upon  the 
amount  of  issue.  The  latter  course  is  likely  to  be  adopted  when 
there  is  free  opportunity  for  the  receiving  bank  to  issue  its  own 
notes.1  The  note  of  the  other  bank  which  it  has  received  on  de-. 
posit  represents  for  it  the  equivalent  of  cash ;  the  note  can  be 
sent  to  the  issuing  bank  for  redemption.  The  bank's  own  notes, 


1  Where,  however,  there  are  many  small  banks,  the  likelihood  is  less ;  because 
of  the  trouble  of  sorting  many  notes  and  sending  them  off  to  distant  places  in 
petty  batches.  This  fact  is  often  forgotten  in  discussions  of  schemes  of  banking 
reform  for  the  United  States. 


BANKING  AND  THE  MEDIUM  OF  EXCHANGE       347 

when  paid  out  over  the  counter,  represent  only  its  credit.  They 
cost  nothing  so  long  as  they  remain  outstanding.  The  bank, 
therefore,  will  use  its  own  notes  for  counter  payments,  or  for  "till 
money."  Notes  of  other  banks  will  be  treated  like  checks; 
both  notes  and  checks  will  be  sent  to  the  clearing  house  for  re- 
demption. In  New  England  this  was  the  common  practise  be- 
fore 1860,  when  there  were  many  banks  both  of  deposit  and  issue, 
and  each  had  the  wish  and  the  liberty  to  extend  its  own  credit  as 
much  as  possible.  A  clearing  house  for  notes  may,  for  con- 
venience, be  separate  from  that  for  deposits.  So  it  was  in  New 
England,  where  the  Suffolk  Bank  was  the  agency  through  which 
notes  were  cleared,  and  where  the  system  hence  came  to  be  known 
as  the  Suffolk  Bank  system.  Whether  through  the  same  clearing 
house  or  a  different  one,  notes  then  return  to  the  banks  as  regu- 
larly as  checks  do.  They  may  then  be  re-issued,  as  deposits 
may  be  re-created.  In  both  cases  the  maintenance  of  their  cir- 
culation depends  on  the  continuing  repute  of  the  bank  and  the 
^unfailing  confidence  of  its  customers. 

But,  as  has  already  been  noted,  and  as  will  be  more  fully  ex- 
plained in  the  next  chapter,  notes  are  not  now  commonly  dealt 
with  by  banks  as  deposits  are :  they  are  rather  treated  like  or- 
dinary cash.  In  most  countries  they  are  both  fortified  and  re- 
stricted by  legislation,  and  for  most  purposes  are  used  like  any  other 
"money. "  Hence  they  are  paid  out  indiscriminately  by  banks, 
as  well  as  by  individuals.  In  that  case  the  process  of  redemption 
is  slow.  One  of  the  most  difficult  problems  of  principle  in  bank- 
ing legislation  is  whether  this  system  is  good,  —  whether  notes 
should  be  hedged  in,  made  absolutely  safe,  amalgamated  as 
completely  as  possible  with  coin ;  or  whether  they  should  be  kept 
strictly  separate  from  legal  tender  money,  treated  as  simple 
demand  obligations,  freely  issued,  and  subject  to  constant  re- 
demption and  re-issue  by  the  banks. 


CHAPTER  25 
BANKING  OPERATIONS 

§  1.  Against  their  demand  liabilities  in  the  form  of  notes  and 
deposits,  banks  must  have  cash,  or  assets  readily  convertible  into 
cash. 

Cash  in  a  bank's  vaults  is  "idle"  money ;  it  is  earning  nothing. 
Whether  the  bank  be  one  of  deposit  or  issue,  it  is  under  con- 
stant temptation  to  reduce  to  the  lowest  terms  its  holdings  of 
specie  or  other  legal  tender  money.  Some  cash  it  needs  to  hold,  in 
order  to  meet  demands  at  the  counter  and  balances  at  the  clear- 
ing house  (unless,  indeed,  the  latter  can  be  met  in  other  ways). 
Some  cash  more  it  may  hold  against  the  contingency  of  a 
"run,"  —  sudden  demands  by  depositors  resulting  from  a  dis- 
trust in  the  bank.  But  this  possibility  is  little  regarded,  as  a 
rule,  unless  under  compulsion  by  the'law.  Why  not  invest  "  idle  " 
cash,  put  it  out  in  loans  or  purchases  of  securities,  and  get  an 
income  ?  Hence  the  actual  holding  of  legal  tender  money  tends 
to  be  reduced  to  the  minimum  which  experience  shows  to  be 
needed  in  the  ordinary  course  of  business.  That  minimum  is 
surprisingly  slender.  Five  per  cent  of  the  demand  obligations 
seems  to  be  ample.  The  English  banks  of  deposit,  which  issue 
no  notes,  and  (for  reasons  to  be  explained  in  the  next  chapter) 
do  not  trouble  themselves  about  any  reserve  against  runs,  rarely 
keep  more  than  this  proportion  against  their  deposits,  and  often 
do  not  keep  so  much.  American  banks  also,  unless  compelled 
by  law  to  keep  more  (as  they  commonly  are)  find  that  they  get 
along  comfortably  with  five  per  cent. 

None  the  less,  the  other  resources  of  a  bank  must  be  of  a  sort 
to  enable  it  to  face  the  fact  of  demand  obligations.  It  must 
have  quick  assets.  Its  loans  are  on  short  time,  and  in  a  well- 
managed  bank  are  marshaled  in  such  a  way  that  some  of  them 

348 


BANKING  OPERATIONS  349 

are  maturing  week  by  week  and  day  by  day.  Recurrently,  at 
short  intervals,  the  bank  becomes  entitled  to  repayment  of  loans, 
and  thus  is  in  a  position  quickly  to  increase  its  cash  or  diminish 
its  demand  liabilities  (i.e.  its  deposits). 

-  The  typical  form  of  the  short-time  loan,  as  has  already  been 
said,  is  discounted  commercial  paper.  All  manufacturers  and  all 
wholesale  dealers,  and  most  retail  dealers,  give  credit  to  pur- 
chasers, and  in  turn  borrow  from  the  banks.  Loans  to  them,  on 
short  time,  and  in  connection  with  their  current  dealings,  are  to  a 
high  degree  secure ;  for  to  meet  them  is  the  first  condition  of  a 
man's  standing  in  the  mercantile  community  and  so  of  the  very 
possibility  of  maintaining  himself  in  business.  By  the  older  tradi- 
tion, the  banker  was  the  confidential  friend  and  adviser  of  the 
business  men  who  were  his  customers;  well-informed  upon 
their  affairs,  and  disposed  to  aid  them  with  credit  according  to 
their  pecuniary  deserts.  This  sort  of  relation,  with  discount  of 
commercial  paper  based  on  it,  still  plays  a  very  large  part  in 
ordinary  banking  operations. 

Side  by  side  with  these  intimate  relations  there  have  always 
been,  and  of  late  have  grown  in  volume  and  importance  (at 
least  in  the  United  States)  transactions  of  a  more  cold-blooded 
sort.  Loans  are  made  with  collateral ;  that  is,  on  the  pledge 
of  property  that  can  be  sold  by  the  bank  if  the  loan  is  not 
promptly  paid.  Securities — stocks  and  bonds  of  all  sorts — are 
the  most  welcome  form  of  collateral,  because  the  stock  exchanges 
give  the  most  perfect  facilities  for  disposing  of  them.  Every 
bank  has  a  certain  proportion  of  loans,  commonly  secured  by 
stock  exchange  collateral,  and  payable  on  demand,  which  it  is 
expected  at  once  to  convert  into  cash  if  there  should  be  any  sud- 
den large  presentation  of  demands  against  the  bank  by  de- 
positors. 

Other  assets  of  a  quickly  realizable  sort  are  also  found  in  a 
bank's  resources.  Familiar  and  easily  salable  securities  are 
often  held,  such  as  can  be  turned  into  cash  at  a  moment's 
notice  in  case  of  need.  Every  English  bank  parades  on  the 
published  balance  sheet  its  consols,  and  treats  these  as  if  they 


350   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

were  the  same  thing  as  cash.  The  United  States  bonds,  and 
the  state  and  municipal  bonds,  which  our  trust  companies  are 
apt  to  enumerate  first  in  their  published  statements,  are  of  the 
same  sort.  When  a  bank,  after  it  holds  as  much  of  such  securi- 
ties as  are  desirable  for  general  safety  and  repute,  still  finds  that 
it  has  more  cash  than  is  needed  for  its  current  operations,  it 
will  "go  into  the  market"  and  buy  with  the  surplus  anything 
that  seems  safe  and  profitable.  It  may  buy  ordinary  "good" 
securities,  even  though  its  usual  course  of  business  is  not  to 
buy  and  sell  stocks  and  bonds.  It  may  buy  "outside  paper" ; 
that  is,  the  promissory  notes  of  business  firms  which  are  not 
its  own  customers  and  depositors.  This  is  done  through  the 
bill  brokers  of  England,  and  the  note  brokers  in  the  United 
States,  —  a  set  of  middlemen  who  have  lately  become  of  grow- 
ing importance  in  American  banking.  The  note  brokers  peddle 
the  commercial  paper  of  well-known  firms  among  banks  whose 
resources  are  temporarily,  sometimes  permanently,  greater  than 
they  can  utilize  among  their  own  clientele.  The  practise  of 
buying  such  notes  of  course  increases  the  range  of  the  banker's 
cold-blooded  operations.  Its  advantages  and  disadvantages 
have  been  much  debated.  It  is  said  to  distribute  the  banker's 
risks  better ;  he  is  not  so  much  bound  up  with  the  fortunes  of 
the  particular  clique  or  trade  that  makes  up  his  regular  cus- 
tomers. On  the  other  hand,  it  makes  him  deal  with  persons 
whose  affairs  he  knows  with  little  certainty ;  and  it  brings  pos- 
sibilities of  overexpansion  by  the  borrowers,  and  of  unexpected 
loss  to  the  bankers. 

A  purely  commercial  bank  confines  itself  to  such  operations 
as  these.  But  a  bank  may  be  more  than  purely  commercial. 
It  may  have  large  deposits  from  persons  not  in  active  business ; 
and  then,  of  course,  is  most  likely  to  buy  general  securities  or 
outside  paper.  More  important  is  the  tendency  to  combine 
general  financing  and  investment  operations  with  commercial 
banking,  a  tendency  which  on  the  whole  seems  to  be  grow- 
ing. The  national  banks  of  the  United  States  and  the  joint 
stock  banks  of  England  are  traditionally  separate  from  pro- 


BANKING  OPERATIONS  351 

moting  and  investment,  and  restrict  themselves  to  commercial 
business.  On  the  other  hand,  as  was  pointed  out  in  the  last 
chapter,  the  great  private  banking  houses  have  been  mainly 
investment  agencies,  nursing  new  enterprises  and  enlisting  a 
clientele  of  well-to-do  customers  who  look  to  them  for  advice 
and  guidance  in  placing  their  accumulations.  Many  large 
institutions  of  modern  times  combine  all  these  kinds  of  bank- 
ing, as,  for  example,  the  great  banking  companies  of  Germany 
and  France.1  A  similar  wide  range  of  operations  is  carried  by 
many  of  the  so-called  trust  companies  of  the  United  States. 
Some  of  these  do  strictly  what  their  name  implies,  —  act  simply 
as  trustees,  administrators,  executors,  fiduciary  agents.  But 
most  of  them  combine  promoting  and  investment  with  bank- 
ing of  the  traditional  sort.  Even  our  national  banks  have  been 
led  by  competition  and  the  search  for  profit  to  enter  on  pro- 
moting and  financing  operations  to  a  greater  degree  than  in 
former  times. 

The  combination  of  different  operations  by  a  single  institu- 
tion, in  close  connection  with  deposit  banking,  brings  dangers. 
The  due  balancing  of  demand  liabilities  with  quick  assets  is 
not  easy  to  maintain  where  other  operations  are  undertaken 
which  look  to  permanent  investment.  The  danger  of  a  com- 
mercial crisis  is  more  imminent  and  more  serious  when  the 
deposits  which  are  payable  on  demand  and  are  interlocked 
with  the  effective  circulating  medium,  are  closely  connected 
with  new  ventures  that  tie  up  resources  for  a  long  time  and 
necessarily  entail  large  risks.  None  the  less,  it  is  probable  that 
this  sort  of  financial  combination  will  be  undertaken  in  the 
future  more  rather  than  less.  It  opens  the  prospect  of  larger 
profits  than  routine  commercial  banking  offers.  It  is  not  easy 
to  restrict  by  legislation,  even. if  restriction  were  clearly  desir- 
able. It  is  in  accord  with  the  general  trend  to  consolidation 
and  large-scale  management ;  and  its  growth  must  be  watched 
with  the  same  uneasy  interest  as  all  the  extensions  of  capitalist 
enterprise  into  larger  and  more  complex  aggregations. 

»Cp.  what  is  said  in  Chapter  26,  §4,  of  the  German  banks.  The  Credit 
Lyonnais,  a  remarkable  institution,  is  the  largest  of  the  French  banks. 


352       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

§  2.  It  is  the  business  of  banks  to  lend.  They  lend  more 
freely  in  proportion  as  their  cash  holdings  or  reserves  are 
large.  Hence  there  is  a  close  connection  between  the  rate  of 
which  bank  loans  are  made,  that  is,  the  rate  of  discount,  and 
the  quantity  of  money  held  by  the  banks. 

A  common  notion  is  that  the  rate  of  interest  depends  on 
the  quantity  of  money,  falling  when  that  is  plentiful,  rising 
when  it  is  scarce.  The  notion,  thus  broadly  stated,  is  absurd. 
The  abundance  of  money  affects  its  exchange  value,  that  is, 
the  general  range  of  prices.  Advocates  of  paper  money  have 
often  supposed  that  a  greater  quantity  of  money  would  lower 
the  rate  of  interest.  In  fact,  as  we  have  seen,  the  period  during 
which  prices  are  rising  is  one  not  of  lower  interest,  but  of  higher. 
When  once  the  definitive  stage  of  higher  prices  has  been  reached, 
there  is  nothing  in  the  nature  of  the  situation  to  make  interest 
higher  or  lower ;  though,  under  a  regime  of  inconvertible  paper, 
it  often  happens  that  the  general  unsettlement  causes  the  risks 
of  lending  to  be  deemed  higher  and  so  raises  the  rate  of  interest 
by  a  sort  of  insurance  premium.  But  all  this  does  not  modify 
in  any  essential  the  general  proposition  that  the  rate  of  interest 
depends,  not  on  the  supply  of  money,  but  on  the  relations 
between  savings  and  their  utilization  in  production.1 

But,  though  the  rate  of  interest  does  not  depend  on  the  quan- 
tity of  money  circulating  in  the  community  at  large,  the  bank 
rate  for  loans  is  affected  by  the  quantity  of  money  which  is 
held  in  the  banks'  vaults.  The  commercial  world  is  constantly 
speaking  of  the  value  of  money  and  the  plentifulness  of  money ; 
and  it  uses  both  phrases  in  a  special  sense,  referring  to  the 
banking  situation.  By  value  of  money  it  means  primarily  the 
rate  of  interest  or  discount  on  short-time  business  loans.  By 
plentifulness  of  money  it  means  a  relative  abundance  of  cash 
in  the  banks,  leading  to  a  free  offering  of  loans.  Relative 
abundance,  be  it  noted :  a  large  or  small  supply  relatively  to 
the  demand  obligations  of  the  banks.  When  they  have  more 
cash  than  seems  needed  for  daily  calls  and  for  safety  or  pru- 

1  See  Book  V,  Chapters  38,  39. 


BANKING  OPERATIONS  353 

dence,  they  lend  freely.  Thereby  they  either  add  to  their 
demand  obligations  (by  increase  of  deposits  or  notes)  or  part 
with  some  of  their  cash  in  the  direct  purchase  of  commercial 
paper  or  securities.  In  either  case  the  relation  of  cash  to 
liabilities  is  altered,  until  something  like  the  normal  situation, 
or  supposed  normal  situation,  is  reached.  Conversely,  when 
the  cash  is  scant  as  compared  with  the  demand  reasonably 
to  be  expected,  banks  draw  in.  They  refuse  to  make  new 
loans,  or  to  renew  old  ones;  or  at  least,  they  "take  care"  of 
their  steady  customers  only,  and  turn  a  deaf  ear  to  others. 
Hence  the  rate  of  discount  varies  according  to  the  plentifulness 
of  cash  held  by  the  banks.  Large  cash  holdings  lead  to  "easy 
money"  and  free  lending,  small  holdings  to  "tight  money" 
and  restricted  lending. 

These  tendencies,  and  the  fluctuations  in  interest  rates 
which  result,  appear  most  conspicuously  in  the  case  of  demand 
loans.  On  these  the  rates  of  interest  may  vary  widely.  A 
demand  loan,  it  must  be  remembered,  is  subject  to  call  by 
either  party :  the  debtor  can  be  called  on  to  repay  at  any 
time,  but  he  also  has  the  option  of  making  repayment  at  any 
time.  When  banks  have  plenty  of  cash,  they  lend  freely,  and 
at  very  low  rates,  on  demand ;  for,  if  other  more  profitable 
ways  of  using  their  funds  should  present  themselves,  they  can 
at  once  call  for  payment  of  the  demand  loans  and  turn  to  those 
more  profitable.  Hence  one  hears  of  call  money  in  New  York, 
where  these  fluctuations  are  most  striking,  quoted  as  low  as 
one  per  cent  a  year.  On  the  other  hand,  a  trader  who  is  in 
stress  for  means  to  meet  immediate  liabilities  will  pay  a  high 
rate  for  a  demand  loan,  knowing  that  he  can  repay  at  any 
time  and  hoping  to  do  so  in  a  few  days.  One  hears  also  of  call 
money  quoted  in  New  York  at  100,  even  at  200  per  cent  a 
year.  Of  course  no  one  would  borrow  at  this  ruinous  rate 
through  a  year ;  but  it  might  be  done  for  a  few  days  in  order 
to  tide  over  an  emergency. 

Demand  loans  are  usually  cold-blooded,  made  to  any  one  on 
the  deposit  of  collateral.  The  debtor  must  pay  without  mercy 

2A 


354   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

when  called  on,  and  if  he  fails  to  do  so,  the  collateral  which 
he  has  given  is  sold  at  once.1  The  loans  are  commonly  con- 
nected with  transactions  on  the  exchange,  especially  on  the 
stock  exchange,  and  are  an  important  part  of  the  mechanism 
by  which  speculation  is  facilitated.  From  the  point  of  view 
of  the  bank,  they  are  a  highly  convenient  part  of  its  business. 
A  profit  is  certain,  sometimes  large,  sometimes  small,  but  always 
appreciable;  and  yet  the  bank's  resources  are  not  tied  up 
and  cash  can  be  called  back  —  at  least  by  the  individual  bank 
—  if  there  is  more  profitable  use  for  it  elsewhere,  or  if  there  is 
a  sign  of  danger.  And  from  the  point  of  view  of  public  ad- 
vantage, there  is  also  some  gain.  For  sundry  useful  business 
transactions  funds  are  wanted  over  short  but  uncertain  periods, 
and  for  these  demand  loans  are  adapted. 

But  there  are  also  grave  public  disadvantages  from  such 
transactions.  They  facilitate  gambling  speculation,  not  only 
in  stocks,  but  in  grain,  cotton,  and  other  standardized  com- 
modities. All  the  real  and  serious  evils  of  speculation  are 
made  greater,  or  at  least  are  made  more  easily  possible,  by  the 
willingness  of  banks  to  lend  funds  on  call  to  any  one  who  will 
pledge  sufficient  security.  Naturally,  with  the  tendency 
toward  specialization  in  all  modern  industry,  there  are  some 
banks  which  turn  more  freely  than  others  to  this  sort  of  lend- 
ing; and  indeed  in  every  great  financial  center  there  are  a 
few  banks  which  make  this  almost  their  exclusive  business. 
Such  lending,  too,  is  closely  connected  with  the  tendency  to 
accumulate  all  spare  bank  cash  in  the  financial  centers,  like 
New  York  and  London ;  a  tendency  which  is  more  particularly 
connected  with  the  development  of  deposit  banking  and  with 

1  Many  loans  which  are  nominally  on  demand,  are  in  reality  not  subject  to 
this  sort  of  drastic  treatment.  Loans  in  this  form  are  made  more  than  in  pre- 
vious times  to  merchants,  taking  the  place  of  sixty-day  or  ninety-day  paper,  yet 
not  essentially  different  from  it.  It  is  understood  that  the  bank  will  not  in  fact 
"sell  out"  the  borrower.  And  even  stock  exchange  call  loans,  when  made  to 
brokers  who  are  regular  customers,  are  payable  on  demand  more  in  name  than 
in  fact.  Banks  like  to  parade  on  their  published  accounts  a  large  volume  of 
demand  loans,  as  if  their  promptly  realizable  resources  were  abundant.  In  fact, 
the  convertibility  into  cash  is  often  more  nominal  than  real. 


BANKING  OPERATIONS  355 

some  of  the  dangers  in  that  system,  of  which  more  will  be  said 
elsewhere. 

The  rate  of  interest  on  ordinary  commercial  loans  —  time 
money  for  thirty  days,  sixty  days,  ninety  days  —  of  course 
shows  much  less  fluctuation  than  that  on  demand  loans.  For 
regular  customers  and  depositors  of  banks,  the  rate  of  discount 
often  varies  very  little,  even  though  cash  in  the  banks  may  be 
more  or  less  abundant;  there  being  an  understanding  that 
they  shall  have  "reasonable"  accommodation  at  a  "fair"  rate, 
that  is,  at  the  customary  or  current  rate.  The  rate  on  ad- 
vances of  this  sort  goes  up  and  down  somewhat,  and  oscillates 
about  the  general  rate  of  return  on  permanent  investments. 
Discounts  for  less  regular  customers  fluctuate  more  sharply 
according  as  the  cash  holdings  of  the  banks  are  larger  or  smaller. 
In  times  of  stress  such  loans  may  be  very  hard  to  get,  and 
may  be  made  at  high  rates,  —  8,  10,  12  per  cent ;  while  regular 
customers  may  still  be  taken  care  of  at  the  traditional  rate,  say 
6  per  cent  or  5  per  cent.  Conversely,  when  money  is  "  easy," 
the  banks  may  buy  "outside  paper"  on  terms  which  yield 
them  less  than  the  usual  rate.  The  business  man,  in  arrang- 
ing his  banking  connections,  often  has  a  choice  between  these 
two  ways  of  securing  his  credit.  He  may  deal  steadily  with 
one  bank,  very  likely  a  conservative  one,  paying  to  it  a  fairly 
steady  rate  of  interest  through  good  times  and  bad,  and  sure 
of  support  in  periods  of  stress.  Or  he  may  float  his  paper 
through  note  brokers,  and  borrow  here  and  there  at  varying 
rates.  Then  he  takes  his  chances  as  to  support  in  the  periods 
when  no  bank  has  much  free  money  and  when  all  business 
men  are  demanding  loans.  The  former  course  is  that  which 
conduces  to  the  safe  and  steady  conduct  of  industry;  the 
latter  is  that  which  promotes  the  recurrence  of  commercial 
crises.  Yet  the  latter  often  seems  immediately  the  more 
profitable,  and,  under  skillful  as  well  as  venturesome  manage- 
ment, may  be  in  fact  the  more  profitable.  In  every  community 
there  will  be  found  the  two  types  of  banks  and  the  two  types 
of  business  men.  The  fluctuations  in  the  rate  of  interest 


356   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

naturally  appear  most  sharply  in  the  dealings  between  the 
venturesome  banks  and  the  venturesome  business  men. 

§  3.  A  successful  banker  or  bank  manager  must  have  above 
all  qualities  that  of  judgment.  He  must  be  a  good  judge  of 
men  and  a  good  judge  of  enterprises.  He  must  be  well  in- 
formed on  what  is  going  on  in  the  community  about  him.  In  a 
strictly  commercial  bank  he  must  have  besides  these  qualities 
a  measure  of  caution.  The  management  of  a  commercial  bank 
is  not  on  the  whole  very  difficult.  It  calls  for  prudence,  pro- 
bity, adherence  to  routine  and  system,  large  acquaintance  in 
the  business  community.  In  all  forms  of  banking,  the  good 
business  repute  of  the  individuals  in  charge  is  a  sine  qua  non. 
The  more  complex  operations  of  a  financing  and  promoting 
institution  call  for  rarer  qualities;  not  only  for  judgment 
and  caution,  but  for  some  venturesomeness  also,  and  for  manag- 
ing ability.  Risks  must  be  taken,  heavy  commitments  made 
to  new  enterprises,  forecasts  made  with  accuracy  for  a  com- 
paratively distant  future,  the  right  men  selected  for  the  con- 
duct of  difficult  operations.  Here  the  born  captain  of  industry 
often  finds  his  richest  opportunities. 

The  profits  of  banking  may  be  great;  and,  as  with  any  in- 
dustry where  good  will  plays  an  important  part,  they  seem 
little  subject  to  the  leveling  influence  of  competition,  even 
though  there  be  no  approach  to  monopoly.  The  essential  ele- 
ment in  a  successful  bank  is  high  repute,  attained  by  a  long  course 
of  prudent  and  well-conducted  business.  Once  the  good  will 
is  built  up,  the  bank  may  maintain  itself  for  an  indefinite  time 
by  mere  size  and  momentum.  It  can  make  new  loans,  create 
new  deposits,  maintain  its  hold  on  its  customers,  and  enlarge 
almost  without  limit.  Though  its  profits  may  be  great,  rivals 
will  find  difficulty  in  competing  with  it,  not  to  speak  of  supplant- 
ing it.  True,  like  all  good  will,  this  cannot  be  maintained  in- 
definitely without  some  effort.  New  banks  will  find  ways  of 
accommodating  or  enticing  customers,  new  blood  will  appear 
in  the  business  community,  old  banks  may  become  fossilized 
and  may  slowly  lose  their  clientele.  But  some  great  banks  in 


BANKING  OPERATIONS  357 

all  the  important  cities  hold  their  own  from  generation  to  genera- 
tion, partly  no  doubt  by  continued  good  management,  but  to 
no  small  degree  from  mere  sustained  good  will. 

§  4.  It  is  often  said  that  a  bank  supplies  capital  and  by  so 
doing  adds  to  the  productive  resources  of  a  community.  In 
the  strict  sense  of  capital  (capital  goods)  a  bank  obviously 
does  nothing  of  the  kind.  Tools,  machinery,  building  materials, 
are  created  by  labor,  not  by  saving  or  lending.  But  a  bank, 
though  it  does  not  create  capital,  is  a  most  important  instru- 
ment in  regulating  the  command  of  capital  and  in  promoting 
the  effective  use  of  capital. 

So  far  as  savings  banks,  investment  banks,  and  similar 
financial  institutions  are  concerned,  nothing  needs  to  be  added 
to  what  has  already  been  said.1  They  are  intermediaries  in 
the  process  by  which  saving  furthers  investment  and  the  making 
of  capital. 

Commercial  banks  have  often  been  described  as  performing 
the  same  functions  in  the  same  way.  They  are  said  to  gather 
rills  of  savings  —  money  means  not  immediately  needed  by 
the  owners  and  deposited  by  them  in  the  bank  —  and  to  lend 
them  to  producers,  very  much  as  savings  banks  lend  the  accu- 
mulations which  are  more  deliberately  set  aside.  So  far  as 
deposits  arise  by  the  actual  putting  into  banks  of  spare  cash, 
this  description  fits.  But  so  far  as  deposits  are  created  by  the 
banks,  and  so  far  as  notes  are  issued  by  them  —  these  being 
the  peculiar  operations  of  commercial  banks  —  the  description 
does  not  fit.  Here  command  of  capital  is  supplied  by  the 
banks  without  that  sort  of  saving  which  is  ordinarily  associated 
with  the  process  of  investment.  Money  means  are  created, 
and  the  command  of  capital  is  supplied,  without  cost  or  sacrifice 
on  the  part  of  any  saver. 

The  social  utility  of  commercial  banking  with  its  costless 
supply  of  funds  is  somewhat  different  from  that  of  other  forms 
of  banking.  It  arises  from  the  fact  that  the  commercial  banks 
facilitate  primarily  the  operations  of  the  active  business  men. 

*See  Book  I,  Chapter  5,  §  4. 


358   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

In  so  doing,  they  bring  about  one  clearly  advantageous  result : 
they  promote  the  continuity  of  industry.  The  merchant  or 
manufacturer  who  has  completed  one  stage  in  his  operations 
need  not  wait,  before  beginning  again,  until  he  has  disposed 
of  the  salable  product,  or  received  the  proceeds  of  a  sale. 
The  bank  enables  him  to  anticipate  what  is  due  him,  or  is 
reasonably  certain  to  come  to  him,  and  so  enables  him  to 
enter  forthwith  on  another  stage.  At  least  equally  im- 
portant, but  not  so  obvious,  is  the  influence  which  banks 
exercise  on  the  make-up  of  the  business  world.  As  will  appear 
in  later  chapters,  something  like  a  process  of  natural  selection 
determines  who  shall  come  to  the  lead  in  the  conduct  of  busi- 
ness.1 In  that  selective  process  the  commercial  banks  play 
a  dominant  part.  They  lend  freely  to  the  men  of  whom  they 
think  well;  they  turn  a  deaf  ear  to  him  whose  projects  seem 
unpromising.  Their  willingness  to  give  credit  makes  it  possible 
for  the  capable  man  to  extend  his  operations,  even  though  he  start 
with  little  or  no  means  of  his  own.  No  doubt  they  sometimes 
make  mistakes,  and  enable  empty  pretenders  or  reckless  specu- 
lators to  get  command  of  large  resources.  But  bankers,  to 
repeat,  need  be  above  all  things  good  judges  of  men.  On  the 
whole,  they  put  the  control  of  the  industrial  forces  into  the 
hands  of  those  likely  to  turn  them  into  profitable  channels. 
They  are  the  leaders  among  the  leaders  in  the  industrial  world. 
Obviously,  bankers  judge  borrowers  solely  according  to 
pecuniary  desert.  They  lend  freely  to  the  man  who  makes 
money.  How  he  makes  money  and  how  far  his  money-making 
conduces  to  the  common  good,  is  none  of  the  banker's  concern, 
no  more  than  it  is  the  lawyer's  professional  concern  to  inquire 
whether  his  client  is  doing  things  for  the  public  ill  or  good. 
So  long  as  the  borrower's  operations  are  within  the  pale  of  the 
law  and  of  current  business  morality,  the  only  question  is 
whether  he  is  "safe"  and  is  likely  to  be  a  profitable  customer 
in  the  present  and  future.  If  money  is  commonly  made  by 
efficient  guidance  of  the  forces  of  production,  banking  con- 

1  See  Book  V,  Chapter  49. 


BANKING  OPERATIONS  359 

tributes  to  that  guidance.  If  money  is  commonly  made  by 
overreaching  others,  by  fraud  or  gambling,  by  taking  advantage 
of  necessitous  laborers,  banking  contributes  to  such  misdirection 
of  energy.  Investment  of  every  sort  through  the  mediation 
of  financial  institutions  stands  or  falls,  as  to  its  social  utility, 
with  the  working  of  the  whole  institution  of  private  ownership 
of  capital.  Commercial  banking  particularly  stands  or  falls, 
as  to  its  social  utility,  with  the  merits  or  demerits  of  the  busi- 
ness man's  doings.  On  these  general  problems,  —  the  crucial 
ones  of  economics,  —  the  last  word  cannot  be  said  until  the 
very  close  of  our  discussion. 


CHAPTER  26 

CENTRALIZED  BANKING  SYSTEMS 

§  1.  The  intimate  connection  of  banking  operations  with 
the  circulating  medium  led  early  to  their  regulation  by  law. 
While  legislation  has  covered  a  wide  field,  it  has  yet  been  directed 
mainly  to  the  monetary  aspects  of  banking.  Partly  under  its 
influence,  partly  under  the  more  elusive  influence  of  national 
custom,  very  different  banking  systems  have  grown  up  in  the 
various  countries.  To  describe  these  in  detail  would  far  trans- 
gress the  scope  of  a  book  like  the  present.  Yet  some  account 
both  of  the  laws  and  of  the  banking  habits  of  leading  nations 
is  essential  for  an  understanding  of  the  general  situation,  and 
particularly  of  the  relation  of  banking  to  monetary  phenomena 
and  to  the  general  movements  of  prices. 

The  need  of  the  regulation  of  note  issues  was  seen  almost 
as  soon  as  the  use  of  bank  notes  began.  It  became  clear  at  a 
very  early  date  that  notes  could  get  into  circulation  easily; 
that  a  bank's  obligation  to  redeem  in  specie  was  often  post- 
poned by  the  continued  circulation  of  the  notes  from  hand  to 
hand ;  that  this  obligation  could  be  evaded  by  a  private  bank 
even  when  the  notes  were  presented  for  payment;  and  that 
unregulated  issue  was  sure  to  bring,  in  a  considerable  proportion 
of  cases,  recklessness  and  eventual  collapse.  The  English- 
speaking  countries  particularly,  such  as  England,  Scotland, 
and  the  United  States,  were  confronted  recurrently  with  heavy 
bank  failures,  entailing  loss  or  even  disaster  for  persons  by 
whom  the  notes  had  been  received  in  the  ordinary  course  of 
dealings.  In  the  first  half  of  the  nineteenth  century  such 
catastrophes  were  all  too  common  in  the  three  countries  named. 
On  the  continent  of  Europe  note  issue  by  banks  had  from  the 
first  been  regarded  as  a  public  function,  and  had  been  permitted 
only  to  institutions  closely  connected  with  the  government  and 

360 


CENTRALIZED  BANKING  SYSTEMS  361 

supervised  by  it.  During  the  nineteenth  century  two  funda- 
mentally different  modes  of  regulation  developed :  the  one 
through  a  great  central  bank,  having  a  monopoly  of  note  issue 
and  possessing  in  large  degree  the  character  of  a  government 
institution;  the  other  through  systematic  supervision  of 
scattered  and  separate  banks.  Centralization  and  public  or 
quasi-public  note  issue  are  on  the  whole  winning  their  way. 
Most  of  the  continental  countries,  as  just  remarked,  have  fol- 
lowed this  principle  from  the  outset.  England  adopted  it  hi 
her  famous  Bank  Act  of  1844.  Switzerland  has  very  recently 
(1905)  changed  from  a  decentralized  system  to  one  of  a  public 
bank  with  sole  right  of  issue.  The  United  States  is  by  far  the 
most  important  of  the  countries  which  still  maintains  manifold 
note  issue ;  with  her  are  Scotland  and  Canada. 

§  2.  Of  central  banks  three  important  and  typical  examples 
are  found  in  the  Bank  of  France,  the  Bank  of  England,  and 
the  Imperial  Bank  of  Germany. 

The  Bank  of  France  is  the  simplest  of  all  the  great  banks, 
and  indeed  among  the  simplest  of  all  banks,  great  or  small. 
It  has  a  monopoly  of  note  issue,  —  no  other  bank  in  France 
may  put  out  notes ;  and  it  is  virtually  under  government 
management.  But  there  is  no  special  regulation  of  its  banking 
operations,  no  separate  provision  looking  to  the  safety  of  its 
notes,  virtually  no  limitation  on  the  amount  of  notes  it  may 
issue. 

The  Bank  of  France  is  a  corporation,  with  stockholders, 
directors,  and  all  the  paraphernalia  of  a  private  institution. 
It  pays  dividends  to  its  stockholders.  But  the  manager  is 
appointed  by  the  government,  and,  though  there  are  consulting 
committees  through  which  the  stockholders  have  some  powers, 
its  direction  is  virtually  in  the  hands  of  the  government.  The 
bank  is  the  fiscal  agent  of  the  government,  being  the  custodian 
of  the  public  funds.  It  has  the  administration  and  recording 
of  the  public  debt  of  France,  —  a  simple  bookkeeping  task,  but 
one  of  great  magnitude  inasmuch  as  the  amount  of  the  debt 
is  enormous.  Much  more  important  is  its  relation  to  the 


362   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

government  as  lender.  When  the  French  treasury  needs 
funds,  it  turns  to  the  Bank  of  France  for  advances.  Its  services 
to  the  country  in  the  trying  period  during  and  after  the  war  of 
1870-1871  can  hardly  be  overestimated.  The  government 
turned  to  it  for  heavy  advances,  which  largely  took  the  form 
of  note  issues.  The  notes  were  made  inconvertible,  —  the 
Bank  was  not  only  allowed  to  refuse  payment  in  specie,  but 
was  inhibited  from  such  payment.  Virtually,  the  Bank  be- 
came the  agent  of  the  government  for  issuing  inconvertible 
paper  money.  But  the  issues  took  the  form  of  loans  to  the 
government,  on  which  interest  was  paid  to  the  Bank ;  and  the 
redemption  of  the  notes  in  specie  was  ultimately  to  be  under- 
taken (and  in  fact  was  undertaken  in  1878)  by  the  Bank. 
It  has  already  been  pointed  out  that  this  is  one  of  the  very 
few  cases  in  which  inconvertible  paper  has  been  issued  without 
leading  to  depreciation,  and  the  only  case  in  which  this  has 
been  done  on  a  large  scale.  That  such  great  aid  was  furnished 
to  the  French  government  and  people,  without  the  demoraliz- 
ing effects  which  usually  flow  from  paper  money,  is  to  be 
ascribed  in  no  small  measure  to  the  fact  that  the  issue  was  not 
made  directly  by  the  government,  but  through  a  bank  which 
was  financially  separate  and  which  could  be  called  on  without 
friction  or  controversy  to  resume  specie  payments  when  the 
time  was  ripe. 

The  Bank  of  France  has  a  monopoly  of  note  issue;  it  may 
do  quite  as  it  pleases  with  regard  to  the  specie  held  in  its  vaults 
for  the  payment  of  the  notes  and  its  other  obligations.  As  a 
matter  of  fact,  it  has  held  during  the  last  generation  a  great 
and  increasing  stock  of  specie,  —  needlessly  large,  if  one  looks 
merely  at  the  safety  and  solidity  of  the  notes.  That  stock  is 
partly  gold,  partly  silver.  The  silver  consists  chiefly  of  the 
overvalued  five-franc  pieces ;  and  these,  though  legal  tender  and 
completely  available  for  the  Bank  in  meeting  its  obligations, 
are  yet  dependent  for  their  current  value  on  the  gold  coin  in 
use  side  by  side  with  them.1  But  the  stock  of  gold  coin — • 

1  See  above,  Chapter  21,  §  2. 


CENTRALIZED  BANKING  SYSTEMS  363 

both  that  held  by  the  Bank  and  that  in  circulation  in  the 
community  —  is  so  large  as  to  prevent  the  silver  from  being 
a  source  of  weakness.  In  recent  years  the  Bank  of  France  has 
held  in  specie — gold  and  silver  together — nearly  as  much  as  the 
total  notes  outstanding.  Until  about  1890,  this  specie  consisted 
in  nearly  equal  parts  of  gold  and  silver ;  but  after  that  date  the 
amount  of  gold  grew  to  be  double  and  triple  that  of  silver,  and 
the  holdings  of  gold  have  become  more  than  ample  for  security. 

The  deposit  obligations  of  the  Bank  of  France  are  compara- 
tively small.  The  habit  of  deposit  banking  and  of  payments 
by  check  has  taken  little  root  in  France.  It  has  established 
itself  only  in  Paris  and  in  a  few  other  large  centers,  and  even 
in  these  only  for  a  limited  circle  of  large  wholesale  dealers  and 
private  bankers.  Most  transactions,  large  as  well  as  small, 
are  settled  in  specie  or  in  Bank  of  France  notes.  Hence  the 
demand  liabilities  of  the  Bank  take  chiefly  the  form  of  notes; 
and  the  deposits  are  so  moderate  that,  even  when  they  are 
added  to  i;he  notes,  the  specie  holdings  are  still  very  large. 

These  specie  holdings  are  large,  undoubtedly,  by  intention. 
The  Bank  being  virtually  a  government  institution,  its  affairs 
are  managed,  not  indeed  without  regard  to  profit  for  the  stock- 
holders, but  very  largely  with  regard  to  the  real  or  supposed 
needs  of  the  community.  Its  great  stock  of  specie,  which  to  a 
money-making  banker  would  mean  so  much  of  needlessly  idle 
funds,  has  been  heaped  up  partly  for  economic  reasons,  partly 
for  political.  On  economic  grounds  it  is  thought  safe  to  have 
a  very  broad  basis  of  specie  and  a  central  bank  of  impregnable 
strength.  On  political  grounds  it  is  desired  to  have  a  great 
stock  of  coin,  and  especially  of  gold,  to  which  the  government 
can  turn  in  case  of  need.  Though  the  Bank  of  France  has  not 
deliberately  set  to  work  to  hoard  gold,  it  has  welcomed  the 
accumulation  in  its  coffers  of  the  gold  which  growing  prosperity 
has  brought  into  the  country,  and  which  has  found  its  way  to 
the  Bank  because  notes  proved  more  convenient  for  larger 
transactions  than  coin  itself. 

Bank  of  France  notes  can  be  issued  only  in  denominations 


364   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

of  fifty  francs  and  over ;  in  practise  few  notes  of  less  than  one 
hundred  francs  are  issued.  The  restriction  insures  a  large 
everyday  use  of  gold,  and  a  saturation  of  the  general  circulat- 
ing medium  with  gold.  This  important  limitation  on  the  use 
of  paper,  the  slight  use  of  deposits  and  checks,  and  habits  of 
deliberation  and  caution  in  the  people  which  make  the  rapidity 
of  circulation  probably  low  for  all  forms  of  the  medium  of  ex- 
change, have  brought  about  a  large  supply  of  money  per  head 
of  population.  France  not  only  is  a  rich  and  populous  coun- 
try, but  has  a  supply  of  specie  large  in  proportion  to  her  riches 
and  population.  This  brings,  no  doubt,  a  safe  and  solid  mone- 
tary system ;  but  it  betokens  also  some  deficiency  in  industrial 
vigor  and  enterprise. 

The  Bank  of  France  supplies  a  perfect  instance  of  elasticity 
in  the  use  of  bank  money.  Whether  through  notes  or  deposits, 
it  is  entirely  free  to  extend  its  operations  as  fast  and  as  far  as 
it  sees  fit.  In  fact,  its  note  issue  fluctuates  very  readily,  en- 
larging and  contracting  from  week  to  week  according  to  the 
calls  on  it  by  the  public.  Yet  it  cannot  be  said  that  the  Bank 
does  for  its  public  everything  which  can  be  expected  of  an 
ideal  banking  system.  The  monopoly  of  note  issue,  and 
management  by  government  officials,  prevent  it  from  feeling 
the  driving  force  of  competition  and  of  immediate  profit,  and 
so  from  extending  its  operations  in  such  a  way  as  to  promote 
business  enterprise  to  the  maximum.  It  is  mainly  a  banker's 
bank.  It  lends  to  bankers,  who  in  turn  lend  to  the  commercial 
public;  or  rather,  it  rediscounts  the  paper  which  the  private 
bankers  and  banking  companies  have  already  discounted. 
These  other  bankers  cannot  use  notes  of  their  own  issue,  being 
prohibited  therefrom  by  law;  and  they  cannot  use  deposits, 
except  on  a  limited  scale  in  Paris  and  the  great  cities.  Hence 
the  French  banking  system  has  serious  drawbacks.  French 
bankers  are  restricted,  and  of  necessity  to  some  degree  cautious. 
There  is  little  opportunity  for  profit  in  strictly  commercial 
banking,  and  no  temptation  to  take  risks  for  the  sake  of  gains. 
Hence  there  is  not  quick  patronage  of  new  men  and  new  enter- 
prises, and  little  stimulus  for  the  bold  and  adventurous. 


CENTRALIZED  BANKING  SYSTEMS  365 

§  3.  A  very  different  type  is  presented  by  the  Bank  of  Eng- 
land. The  organization  of  this,  the  earliest  and  most  famous 
of  the  great  modern  public  banks,  is  regulated  by  the  Bank 
Act  of  1844.  But,  like  almost  all  British  institutions,  the 
Bank  of  England  is  regulated  not  only  by  statute,  but  by  a 
body  of  customs  and  traditions  which  are  no  less  binding  than 
statutes,  and  which  are  in  this  case  of  at  least  as  great  economic 
consequence. 

The  salient  feature  of  the  Bank's  organization  is  the  com- 
plete separation  of  note  issue  and  deposit.  Notes  are  put  out 
by  the  Issue  Department,  having  the  function  of  issue  and 
that  only.  Deposits  are  managed,  and  the  real  business,  or  at 
least  the  main  business,  is  conducted  by  the  Banking  Depart- 
ment. To  all  intents  and  purposes  the  two  departments  are 
separate  institutions. 

The  operations  of  the  Issue  Department  are  very  strictly 
limited.  Up  to  a  specified  amount  it  may  put  out  notes,  hold- 
ing as  security  for  them  government  obligations,  but  not  coin. 
For  every  note  beyond  this  amount  it  must  hold  pound  for 
pound  in  gold.  The  specified  uncovered  amount  was  fixed  in 
1844  at  £14,000,000.  It  was  provided  that,  according  as 
other  banks  then  having  the  privilege  of  note  issue  (all  of 
them  country  banks)  should  withdraw  from  business,  or  for  any 
reason  should  cease  their  issues,  the  Bank  of  England  might 
enlarge  its  uncovered  limit  by  two  thirds  the  amount  of  notes 
previously  permitted  to  these  country  banks.  The  expectation 
was  that  the  other  banks  would  gradually  cease  their  issues, 
and  that  the  Bank  of  England  would  secure  a  complete  monopoly 
of  notes.  Under  this  provision  the  Bank's  uncovered  issue  has 
slowly  risen,  until  in  1907  it  amounted  to  £18,450,000.  The 
process  of  extinction  for  other  notes  has  gone  on  steadily,  and 
their  amount  has  become  comparatively  small  (less  than 
£2,000,000). 

The  principle  underlying  this  regulation  of  the  Issue  Depart- 
ment was  that  a  certain  volume  of  notes  would  find  ready 
circulation  and  use,  and  could  be  issued  without  danger  of 


366   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

causing  inflation  or  of  completely  expelling  specie.  This 
volume  was  represented  by  the  fixed  limit  of  uncovered  issue. 
Notes  issued  over  and  above  this  limit  were  to  be  really  in 
the  nature  of  certificates  of  deposit.  In  so  far,  the  theory  of 
the  Bank  Act  was  sound,  and  its  application  has  proved  wholly 
within  the  bounds  of  moderation.  The  limit  set  to  the  un- 
covered issue  in  1844  was  such  as  to  prevent  the  notes  from 
being  then  a  cause  of  danger  to  the  stability  of  the  monetary 
system.  With  the  increase  of  population  and  wealth  since 
that  date,  the  limit  has  become  superlatively  safe. 

The  total  amount  in  circulation  is  much  beyond  the  limit  ; 
but  the  excess  represents  notes  which  are,  in  essentials,  certifi- 
cates of  deposit,  and  are  used  simply  because  more  convenient 
than  coin.  No  Bank  of  England  note  can  be  issued  for  less 
than  £5, — a  restriction  which  causes  gold  coin  to  be  required 
for  a  great  number  of  transactions,  and  probably  limits  very 
much  the  extension  of  the  coin-covered  note  issue.  The  busi- 
ness of  the  Issue  Department  is  now  mainly  that  of  the  ex- 
change of  coin  for  notes  and  notes  for  coin  according  to  the 
convenience  of  one  or  the  other  to  the  holder.  Bank  of  Eng- 
land notes  have  long  been  synonymous  with  gold ;  they  pass 
the  world  over  as  equal  to  the  coin.  They  are  legal  tender 
in  Great  Britain,  except,  of  course,  in  payments  by  the  Bank 
itself,  which  must  redeem  them  in  gold.  But  their  legal  tender 
quality  adds  nothing  to  their  ready  circulation  or  international 
repute. 

Entirely  different  is  the  position  of  the  Banking  Department. 
This  is  a  pure  bank  of  deposit,  —  the  most  important  bank  of 
deposit  in  the  world.  It  is  entirely  unregulated  by  law ;  yet 
it  is  so  regulated  by  custom  as  to  be  no  less  safeguarded  than  the 
Issue  Department. 

The  Banking  Department  is  the  center  of  a  great  system  of  de- 
posit banking.  Deposit  banking  in  the  modern  sense  was  prac- 
tised on  a  considerable  scale  in  England  in  the  eighteenth  century 
(the  London  Clearing  House  dates  from  1775),  and  since  then  has 
had  a  continuous  development.  England  and  Scotland,  and  to  a 


CENTRALIZED  BANKING  SYSTEMS  367 

large  extent  Ireland  also,  are  permeated  by  numerous  banks  of 
deposit,  extending  credit  freely  in  that  form,  having  vast  deposit 
liabilities,  and  utilizing  to  the  full  the  machinery  of  checks  and 
clearing  houses.  Some  of  these  banks  are  the  historical  private 
banks,  which  usually  carry  on  also  a  financing  and  investment 
business.  Others  are  great  joint-stock  banks,  more  likely  to 
confine  themselves  to  commercial  business.  On  the  whole,  the 
joint-stock  banks  have  gained  on  the  private  banks,  and  many  of 
the  latter  have  changed  to  the  joint-stock  form.  All  of  these, 
however,  sail  close  to  the  wind  so  far  as  cash  holdings  are  con- 
cerned. They  keep  as  much  cash  as  is  needed  for  current  de- 
mands, but  little  in  the  way  of  extra  reserve.  Part  of  their 
resources,  often  a  considerable  amount,  is  invested  in  consols, 
which  are  readily  salable ;  and  they  have  a  good  deal  of  "money 
on  call,"  that  is,  demand  loans.  But  their  actual  cash  is  usually  at 
the  minimum  needed  for  ordinary  demands  at  the  counter, — not 
often  five  per  cent  of  the  deposits.1  But  they  do  keep,  in  addition, 
a  certain  amount  on  deposit  in  the  Bank  of  England,  and  this 
they  regard  as  perfectly  equivalent  to  cash  on  hand.  We  have 
already  noted,  in  describing  the  clearing-house  system,  that  the 
Bank  of  England  (which  means  its  Banking  Department) 
serves  as  the  agency  for  settling  balances  between  banks ;  clear- 
ing-house settlements  being  made,  not  in  cash,  but  by  checks  on 
the  Bank.  Hence  every  important  bank  keeps  an  account  with 
the  great  central  institution,  —  an  account  which  fluctuates  from 
time  to  time,  according  to  debit  or  credit  at  the  clearing  house, 
but  which  is  steadily  maintained  at  a  substantial  amount.  It 
serves  to  meet  clearing-house  debts ;  it  serves  also  as  a  resource 
in  case  of  general  uneasiness  or  of  any  unusual  demands  by  the 
particular  bank's  creditors. 

The  Bank  of  England  thus  has  in  its  Banking  Department 
great  deposits  due  to  other  banking  institutions.  It  has  also 

1  The  English  banks  (other  than  the  Bank  of  England  and  a  single  large 
joint-stock  bank)  do  not  state  their  cash  separately ;  they  lump  together,  as 
resources  immediately  available,  their  cash,  money  on  call,  and  deposits  in  other 
banks,  and  often  include  consols  in  this  same  lump  sum.  Their  cash  holdings  can 
only  be  inferred. 


368   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

deposits  due  to  its  own  mercantile  customers,  —  usually  firms 
conducting  large-scale  operations,  —  and  to  financial  and  in- 
vesting brokers  and  middlemen  at  large.  Against  this  mass  of 
demand  liabilities  it  is  under  no  legal  obligation  to  keep  any  speci- 
fied holding  of  cash.  Yet  by  tradition  and  custom  it  is  bound  to 
keep  a  "reserve,"  or,  rather,  the  reserve, — the  store  of  cash  on 
which  the  business  community  looks  as  the  stay  and  prop  of  the 
entire  banking  system.  That  cash  is  expected  to  be  between 
forty  and  fifty  per  cent  of  the  demand  liabilities,  —  vastly 
more  than  is  necessary  for  ordinary  demands.  The  Bank  is  not 
managed  in  this  regard  solely  for  profit,  or  even  primarily  for 
profit.  It  is  managed  as  a  public  institution.  In  its  Banking 
Department  by  custom,  as  in  its  Issue  Department  by  law,  it  is 
the  guardian  of  the  solidity  of  the  English  monetary  system. 

The  large  reserve  of  the  Bank,  and  its  consequent  freedom 
and  strength,  enable  it  to  give  support  in  two  ways.  It  can  pay 
out  cash  to  any  depositor  who  wants  it,  and  it  can  make  loans 
freely  to  any  person  who  needs  them.  Making  loans  means 
creating  deposits,  and  creating  deposits  means  that  the  bor- 
rower is  put  in  a  position  of  security,  —  he  can  have  cash 
if  he  needs  it,  and  he  is  assured  of  meeting  his  liabilities  if  they 
press  heavily  or  unexpectedly  upon  him.  This  sort  of  aid  the 
Bank  can  extend  to  the  other  banks  if  they  are  in  straits  and  yet 
are  solvent.  It  can  extend  the  aid  also  to  the  general  mercantile 
public,  though  it  is  less  likely  to  aid  the  general  public  directly, 
than  indirectly  by  enabling  the  other  banks  to  do  so. 

To  maintain  its  reserve,  the  Bank  adjusts  its  rate  of  discount, 
raising  the  rate  when  the  reserve  is  undesirably  small,  lowering 
it  when  the  reserve  is  needlessly  large.  Such  is  the  natural 
policy  of  any  bank;  but  this  policy  is  followed  most  steadily 
and  with  most  conscious  intent  by  the  great  public  institutions 
of  which  the  Bank  is  the  type.  The  movements  of  the  Bank  rate 
of  discount  are  closely  connected  with  the  mechanism  of  foreign 
trade  and  the  flow  of  specie  from  country  to  country,  of  which 
more  will  be  said  when  the  subject  of  foreign  trade  is  reached. 

The  working  of  all  this  mechanism  in  times  of  crisis  is  curious ; 


CENTRALIZED  BANKING  SYSTEMS  369 

and,  although  the  full  consideration  of  crises  must  be  postponed, 
the  peculiar  relation  of  the  Issue  and  Banking  departments  at 
such  times  may  be  described  here.  It  is  an  odd  relation  :  the 
very  device  which  was  adopted  to  prevent  crises  is  used  for  allay- 
ing them  by  being  set  aside.  When  the  present  system  was 
established  in  1844,  it  was  expected  that  the  rigid  restriction  of 
note  issues  would  prevent  crises,  their  cause  being  supposed  to 
lie  in  unregulated  note  issue.  Experience  soon  showed  that  this 
expectation  was  without  ground.  Crises  recurred,  and  no  less 
severely.  But  it  appeared  also  that  pressure  during  a  crisis  was 
directed  on  the  Banking  Department.  To  this  the  depositing 
banks  looked  for  cash ;  to  this  uneasy  and  hard-pressed  bankers 
and  mercantile  firms  looked  for  loans.  In  the  crisis  of  1847, 
very  shortly  after  the  passage  of  the  act  in  1844,  the  Bank,  being 
confronted  in  its  Banking  Department  by  a  double  demand  for 
providing  cash  and  loans,  secured  from  the  government  a  sus- 
pension of  the  act  of  1844.  That  is,  it  secured  authority  to  put 
out  more  uncovered  notes  from  the  Issue  Department  than  the 
fixed  sum  specified  in  the  act.  The  Banking  Department,  it 
must  be  remembered,  is  normally  in  the  same  relation  to  the 
Issue  Department  as  the  general  public  is.  It  holds  notes 
which  the  Issue  Department  must  redeem  in  specie,  the  bulk  of 
its  cash  being  usually  in  the  form  of  notes.  But  when  the  act 
was  suspended,  the  Banking  Department  could  take  to  the  Issue 
Department  government  securities  and  get  notes  in  exchange. 
The  Issue  Department,  by  handing  out  additional  notes  covered 
by  these  securities,  enlarged  by  so  much  the  holdings  of  cash  in 
the  Banking  Department.  No  breath  of  suspicion  or  uneasiness 
has  ever  attached  to  the  Issue  Department.  Bank  of  England 
notes  have  retained,  and  indeed  had  attained  even  before  1844, 
their  sterling  repute.  The  suspension  of  the  act  thus  operates 
as  a  means  to  supply  the  Banking  Department  with  additional 
cash  in  times  of  great  emergency. 

This  mere  possibility  of  getting  additional  cash  has  served  to 
dispel  uneasiness  and  allay  a  panic.  It  is  security,  the  certainty 
of  finding  support  if  needed,  that  is  really  wanted  in  such  times. 

2B 


370        MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

People  do  not  want  cash ;  they  wish  to  be  sure  of  getting  it  if 
wanted.  The  suspension  of  the  act  puts  additional  supplies  of 
cash,  potentially  unlimited,  at  the  disposal  of  the  Banking 
Department.  The  mere  knowledge  of  the  existence  of  this  re- 
source restores  confidence.  In  fact,  the  Bank  has  never  called 
for  additional  uncovered  issues  to  any  considerable  extent.  The 
act  was  first  suspended  in  1847,  and  again  in  1857  and  in  1866. 
In  later  times  of  panic  its  suspension  has  been  under  consideration, 
but  has  not  in  fact  been  resorted  to.  It  is  to  be  added,  more- 
over, that  the  Bank  has  learned  during  the  last  half  century  both 
to  appreciate  more  fully  its  own  public  responsibility,  and  to  deal 
more  promptly  and  effectively  with  the  conditions  of  incipient 
panic. 

The  present  public  position  of  the  Bank  of  England  is  the 
more  striking  because  it  is  not  only  a  private  corporation,  like 
the  Bank  of  France,  but,  unlike  its  great  rival,  is  managed  quite 
without  government  intervention.  It  is  not  even  managed  by 
bankers.  It  has  a  board  of  directors,  who  by  long  custom  must 
not  be  bankers ; l  they  elect  from  their  number  a  governor  and  a 
deputy  governor,  each  of  whom  holds  office  for  but  two  years. 
If  one  were  to  plan  deliberately  the  organization  of  a  great  public 
bank,  nothing  of  this  sort  would  possibly  be  hit  on;  indeed, 
a  priori,  one  would  think  it  the  worst  possible  arrangement. 
Yet,  like  so  many  British  institutions,  developed  tentatively  and 
incrusted  with  a  mass  of  binding  traditions,  it  works  very  well 
indeed. 

§  4.  The  Imperial  Bank  of  Germany,  or  Reichsbank,  is  mod- 
eled somewhat  on  the  Bank  of  England.  But  the  model  is  im- 
proved in  some  respects,  while  its  actual  working  is  much  affected 
by  the  great  differences  in  business  habits  between  the  two  coun- 
tries. 

The  Imperial  Bank  was  established  in  1875,  and,  as  in  Eng- 
land, was  expected  to  become  eventually  the  sole  note-issuing 

1  This  statement  should  be  qualified.  Certain  classes  of  persons  whom  the 
English  dub  "  merchants,"  but  whose  business  operations  are  largely  of  a  bank- 
ing kind,  may  be  directors. 


CENTRALIZED  BANKING  SYSTEMS  371 

institution.  As  in  England,  banks  of  issue  previously  existing 
were  allowed  to  continue  their  notes,  subject  however  to  con- 
siderable restriction.1  Whatever  note  issue  is  given  up  by  them 
falls  to  the  Reichsbank.  By  this  process  the  Reichsbank  also 
has  gradually  come  to  possess  to  all  intents  and  purposes  a  mo- 
nopoly of  the  right  of  issue,  the  total  issues  by  other  banks  hardly 
exceeding  one  tenth  of  its  notes.  For  the  Reichsbank  (and  for 
each  of  the  smaller  banks  also)  the  principle  of  a  limited  un- 
covered issue  was  established.  The  Bank  may  issue  notes  (1909) 
up  to  a  total  of  550,000,000  marks,  without  having  them  cov- 
ered by  cash ;  for  every  sum  beyond  this  limit  mark  for  mark 
must  be  held  in  specie. 

The  further  regulation  of  this  uncovered  issue,  however, 
proceeds  in  a  way  very  different  from  the  English.  In  the  first 
place,  the  securities  to  be  held  for  the  uncovered  issue  must  not 
necessarily  be  government  securities  as  in  England ;  they  may 
be  ordinary  discounted  paper.  More  significant  is  the  absence 
of  any  separate  holding  of  specie  against  the  notes.  The  cash 
held  against  the  covered  notes  is  not  impounded  in  an  Issue  De- 
partment and  held  specifically  for  the  redemption  of  notes ;  it  is 
simply  the  general  cash  held  by  the  Bank  against  all  its  liabilities. 
If  these  liabilities  were  solely,  or  almost  solely,  in  the  form  of 
notes,  this  difference  would  not  be  important.  If,  on  the  other 
hand,  the  Reichsbank  were,  like  the  Bank  of  England,  the  center  of 
an  all-pervading  deposit  system,  it  would  be  of  very  great  impor- 
tance. In  fact,  the  situation  is  midway.  The  Reichsbank  has 
considerable  deposits;  but  the  main  form  in  which  it  extends 
credit  is  that  of  notes,  and  the  greater  part  of  its  liabilities  is  in 
notes.  Though  its  cash  must  protect  the  deposits  as  well  as  the 
notes,  the  amount  held  is  superlatively  ample  to  protect  both 
forms  of  liability.  Like  the  Bank  of  France,  the  Reichsbank  has 

1  The  only  other  note-issuing  banks  in  Germany  are  the  state  banks  of  Ba- 
varia, Saxony,  Wurttemberg,  and  Baden.  Their  total  uncovered  issue  was,  in 
1909, 68,700,000  marks.  They  are  often  spoken  of  by  the  Germans  as  "private" 
banks,  by  way  of  distinguishing  them  from  the  Reichsbank.  In  the  text,  when 
speaking  of  German  "private"  banks,  I  refer  not  to  these,  but  to  the  great  mass 
of  non-public  institutions  having  no  note  issue  at  all. 


372   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

added  very  much  to  its  stock  of  specie  (most  of  it  gold)  during 
the  last  thirty  years,  and  has  been  able  to  put  out  an  increasing 
quantity  of  notes  covered  by  cash,  —  a  growth  due  partly  to  the 
increase  of  population  and  wealth,  partly  to  a  growing  habit  of 
using  paper  representatives  for  specie. 

Still  another  peculiarity  of  the  Reichsbank  is  the  elastic  limit, 
so-called,  of  its  note  issue.  The  limitation  of  the  uncovered 
issue,  whether  by  the  Reichsbank  or  by  the  minor  banks,  is  not 
absolute.  They  may  issue  beyond  the  limit,  but  must  pay  a 
tax  at  the  rate  of  five  per  cent  a  year  on  the  excess.1  This  provi- 
sion, unique  when  adopted,  was  clearly  suggested  by  the  awkward 
English  expedient  of  suspending  the  Bank  Act.  Recognizing 
that  there  would  be  times  when  a  freer  issue  might  be  to  a  high 
degree  desirable,  the  Germans  allowed  it,  yet  with  a  handicap,  in 
the  form  of  the  tax,  so  heavy  as  to  prevent  recourse  to  it  unless 
really  called  for.  This  extra  tax-weighted  issue  may  be  regarded 
as  an  emergency  issue.  But  its  working  in  a  country  like  Ger- 
many, where  deposit  banking  has  so  moderate  a  development, 
takes  place  under  conditions  very  different  from  those  in  Eng- 
land. The  extra  issue  has  in  fact  been  used  not  infrequently 
by  the  Reichsbank,  and  has  served  a  good  purpose,  at  times  when 
the  community  was  in  need  of  more  abundant  banking  accom- 
modation. But  its  use  has  not  been,  like  the  suspension  or 
threatened  suspension  of  the  English  Act,  the  symptom  or  the 
remedy  for  panics. 

The  relation  of  the  Reichsbank  to  the  general  banking  system 
of  the  country  is  more  like  that  of  the  Bank  of  France  than  that  of 
the  Bank  of  England,  though  in  many  respects  it  follows  ways  of 
its  own.  As  has  already  been  said,  there  is  in  Germany  no  such 
use  of  deposits  and  checks  as  in  England,  and  no  such  vast  vol- 
ume of  deposit  liabilities.  There  is,  indeed,  greater  use  of  de- 
posits than  in  France.  Both  the  Reichsbank  and  the  great 

1  In  the  case  of  the  Reichsbank,  however,  recent  legislation  (1909)  has  per- 
mitted the  issue,  without  payment  of  tax,  of  an  additional  200,000,000  of  marks 
at  the  end  of  the  months  of  March,  June,  September,  and  December ;  the  intent 
being  to  provide  currency  at  those  dates  for  the  heavy  quarterly  payments 
then  customary. 


CENTRALIZED  BANKING  SYSTEMS  373 

private  banks  have  encouraged  this  form  of  bank  operations,  and 
with  some  results ;  yet  after  all  with  nothing  like  what  has  de- 
veloped spontaneously  in  English-speaking  countries.  The  pri- 
vate banks,  being  debarred  by  national  custom  from  any  wide 
use  of  deposits  and  by  law  from  the  use  of  notes,  turn  to  the 
Reichsbank  for  aid  in  the  extension  of  current  commercial 
credit.  As  much  as  one  half  of  the  total  commercial  paper 
discounted  in  Germany  finds  its  way,  chiefly  through  rediscount 
by  other  banks,  into  the  hands  of  the  Reichsbank.  The  Reichs- 
bank has  very  greatly  facilitated  payments  within  Germany, 
by  its  widely  ramifying  system  of  branches,  through  which  it 
effects  payments  freely  between  one  part  of  the  country  and 
another.  Its  services  to  industry  have  been  great,  and  have 
been  rendered  with  an  energy  and  a  conscious  purpose  charac- 
teristic of  the  Germans  of  the  present  generation.  Like  the  Bank 
of  France,  though  a  private  corporation,  it  is  managed  by  gov- 
ernment-appointed officials,  and,  like  all  the  great  public  banks, 
with  a  steady  view  to  public  advantage  rather  than  private 
profit. 

Among  the  striking  industrial  changes  in  Germany  since  1870 
(no  country  has  shown  changes  more  striking)  has  been  the 
growth  of  the  great  banking  corporations,  especially  the  noted 
trio,  —  the  Deutsche  Bank,  the  Dresdner  Bank,  the  Diskonto-Ge- 
sellschaft.  In  the  extent  of  their  operations,  these  are  strong 
rivals  to  the  Reichsbank ;  but  their  operations  are  of  a  differ- 
ent character.  They  combine  all  sorts  of  banking  operations. 
They  do  the  business  of  ordinary  commercial  banks,  partly 
by  some  use  of  deposits  in  the  large  centers,  partly  by  rediscount- 
ing  at  the  Reichsbank.  They  do  also  a  very  great  investing 
and  promoting  business,  by  no  means  limited  to  Germany,  but 
extended  with  remarkable  enterprise  and  skill  to  all  parts  of  the 
world.  Their  deposits  are  in  the  main  what  most  people  think 
of  as  "deposits,"  — not  credits  created  by  them,  but  funds  left 
with  them  for  temporary  or  permanent  investment.  They 
have  built  up  a  great  business  of  many  kinds,  with  large  commit- 
ments, large  liabilities  on  time  and  on  demand,  upon  a  very 


374   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

narrow  basis  of  cash.  They  rely  on  the  Reichsbank  for  support 
in  case  of  stress,  very  much  as  the  English  banks  rely  on  the 
Bank  of  England.  The  Reichsbank  itself,  closely  connected  in 
its  current  dealings  with  the  other  institutions,  yet  stands  aloof 
from  them.  '  It  has  great  cash  reserves,  almost  unlimited  po- 
tential resources,  an  unshakable  prestige.  For  every  solvent 
institution,  and  for  the  business  community  at  large,  it  promises 
unfailing  and  adequate  support  in  times  of  trouble.  Its  great 
service  to  Germany  has  been  to  supply  a  firm  foundation,  not 
only  for  the  circulating  medium,  but  for  the  whole  structure  of 
industrial  credit. 


CHAPTER  27 
THE  BANKING  SYSTEM  OF  THE  UNITED  STATES 

§  1.  THROUGH  the  greater  part  of  the  history  of  the  United 
States,  and  more  particularly  during  the  half-century  from  the 
close  of  the  civil  war  until  1914,  this  country  furnished  the 
most  important  example  of  a  decentralized  banking  system. 
But  the  Federal  Reserve  Act,  passed  in  1913  and  put  into  effect 
in  1914,  transformed  the  system  into  one  partly  centralized, 
partly  decentralized.  New  arrangements  and  requirements 
were  superimposed  on  the  old.  The  resulting  situation  can 
best  be  described  by  first  explaining  the  previous  national 
banking  system  and  then  pointing  out  in  what  way  it  was 
remodelled. 

Under  the  earlier  legislation,  note  issue  was  limited  to  the 
national  banks.  The  limitation  was  accomplished  by  a  tax  on 
other  issues  so  heavy  as  to  be  prohibitory.  The  national  banks 
might  issue  notes  on  depositing  government  bonds  as  security 
at  the  Treasury  of  the  United  States.  These  bonds  remained 
the  property  of  the  several  banks,  which  received  the  interest 
on  them.  Notes  might  be  issued  up  to  the  par  value  of  the 
bonds,  but  not  exceeding  the  market  value.  The  bonds  served 
to  insure  the  payment  of  notes  if  a  bank  should  fail,  or  if  it 
should  withdraw  from  business.  In  such  case,  the  Treasury 
disposed  of  the  bonds,  repaying  to  the  bank  any  premium  they 
might  bring  over  par ;  or  the  bank  itself  (directly  or  through 
its  receiver  in  case  of  insolvency)  might  turn  over  to  the  Treas- 
ury cash  enough  to  pay  all  its  notes  outstanding,  and  then 
resume  possession  of  the  bonds,  and  do  as  it  would  with  them. 
In  addition  to  this  security  for  eventual  repayment,  each  bank 
was  required  to  keep  at  the  Treasury  a  cash  fund  of  five  per 
cent  of  its  circulating  notes,  to  provide  for  their  immediate 

375 


376  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

redemption  if  presented.  The  system  had  a  certain  resem- 
blance to  that  of  the  Bank  of  England,  in  that  a  specific  portion 
of  the  bank's  property  was  set  aside  for  the  security  of  the  notes, 
and  held  solely  for  that  purpose.  This  segregated  property 
was,  for  the  national  banks,  almost  all  in  securities,  with  a  little 
in  cash ;  for  the  Bank  of  England,  it  is  preponderantly  in  cash, 
and  only  a  moderate  proportion  is  in  securities.  No  limit  was 
imposed  upon  the  total  amount  of  notes  that  might  be  issued. 
Each  individual  bank  was  indeed  restricted;  it  might  issue 
notes  only  up  to  the  amount  of  the  bonds  deposited,  and  in 
any  case  only  up  to  its  capital  as  a  maximum.  But  the  amount 
issuable  by  the  banks  as  a  whole  had  no  limit. 

Through  this  strict  regulation  national  bank  notes  were 
made  secure  beyond  any  question.  Their  redemption  in  legal 
tender  money  was  no  less  assured  than  that  of  Bank  of  England 
notes.  Hence  they  circulated  as  freely  as  these,  and  with  as 
little  likelihood  of  being  presented  by  the  public  at  the  issuing 
bank.  This  favorable  outcome  is  inevitable  whenever  bank 
notes  are  made  good  beyond  peradventure.  Every  person  ac- 
cepts them  unhesitatingly  as  money,  and  passes  them  to  the 
next  person  in  making  payments.  Not  only  every  individual, 
but  every  bank,  treats  them  once  for  all  as  money,  and  pays 
them  out  in  the  ordinary  course  of  transactions.  National 
banks,  it  is  true,  sometimes  exercised  discrimination  in  paying 
them  out  over  the  counter.  By  preference  tney  paid  out  na- 
tional bank  notes  (those  of  other  banks  as  well  as  their  own) 
rather  than  legal  tender  notes  or  specie;  because  the  latter 
counted  as  reserve  against  deposits,  whereas  national  bank 
notes  could  not.  But  presentation  of  a  national  bank  note  for 
redemption  at  the  counter  of  the  issuing  bank  never  took  place. 
National  bank  notes,  once  set  afloat,  remained  in  circulation, 
quite  regardless  of  the  credit  of  the  banks  whose  name  they  bore, 
and  in  large  measure  regardless  of  the  continuance  of  the  con- 
ditions which  brought  about  their  original  issue. 

In  this  part  of  the  banking  system  no  immediate  change  was 
made  by  the  legislation  of  1913.  A  radical  readjustment  was 


BANKING  SYSTEM  OF  THE  UNITED  STATES     377 

indeed  contemplated,  and  in  some  measure  provided  for,  —  one 
by  which  the  entire  business  of  note-issue  would  eventually  be 
taken  away  from  the  then  existing  banks  and  turned  over  to  the 
Reserve  Banks,  to  be  presently  described.  But  only  tentative 
and  half-hearted  steps  were  taken  in  this  direction.  A  some- 
what intricate  arrangement  was  set  up  by  which,  through 
gradual  steps  extending  over  a  period  of  thirty  years,  the 
Reserve  Banks  were  to  buy  from  the  national  banks  the  bonds 
set  aside  as  security  for  notes  and  to  replace  the  national  banks 
as  issuers  of  notes.  It  is  probable,  however,  that  before  the 
thirty-year  period  is  up,  perhaps  at  an  early  stage  in  it,  still 
further  legislation  will  be  enacted  on  this  troublesome  part  of 
the  banking  and  currency  system ;  and  it  would  be  premature 
now  (1914)  to  speculate  what  further  measures  are  likely  to 
come. 

§  2.  By  far  the  most  important  feature  of  banking  habits  and 
practises  in  the  United  States  is  the  wide  use  made  of  deposits. 
What  has  been  said  of  banking  operations  in  the  preceding 
chapter  is  here  strikingly  exemplified  in  a  system  that  ramifies 
far  into  the  country's  entire  economic  structure.  And  the 
regulation  of  that  system  by  law  is  unique.  No  other  country 
has  grappled  by  direct  legislation  with  the  problems  presented 
in  deposit  banking. 

National  banks  were  always  required,  and  are  still  required, 
to  keep  a  stated  "reserve"  against  their  deposits.  The  re- 
quirement is  different  for  banks  in  different  sorts  of  places,  the 
general  principle  being  that  more  shall  be  held  in  the  large 
financial  centers,  less  in  the  small  places.  For  this  purpose  the 
banks  were  divided  under  the  old  system  into  three  groups. 
The  grouping  was  maintained  in  the  act  of  1913,  and  even  the 
old  designations,  though  deprived  of  their  former  significance, 
were  maintained.  The  first  group  comprised  the  three  "central 
reserve  cities,"  New  York,  Chicago,  and  St.  Louis ;  among  which 
New  York  was  so  much  the  most  important  that  it  was  common 
to  think  of  this  as  the  central  reserve  city.  Second  came  the 
banks  of  "reserve  cities,"  —  other  centers  of  considerable  size, 


378  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

some  forty  or  fifty  in  number.1  Finally,  the  third  group  in- 
cluded the  remaining  banks,  usually  spoken  of  as  "country 
banks."  In  general,  the  banks  of  the  first  and  second  groups 
were  required  to  keep  a  reserve  of  25  per  cent  against  their 
deposits,  those  of  the  third  group  one  of  15  per  cent.  But  the 
country  banks  were  permitted  to  keep  a  large  part  of  their  re- 
serve, not  in  cash,  but  in  the  form  of  deposits  in  other  banks 
(national  banks  of  either  reserve  city  or  central  reserve  city) ; 
while  the  numerous  reserve  city  banks  also  were  permitted  to 
keep  as  much  as  one-half  of  their  reserve  in  the  form  of  deposits 
in  the  national  banks  of  the  three  central  cities.  Only  for  the 
last  named  (the  central  reserve  city  banks)  was  there  a  require- 
ment that  the  holdings  should  be  entirely  in  cash.  The  conse- 
quence was  a  process  of  attentuation.  The  country  banks  kept 
part  of  their  required  reserves  not  in  cash,  but  in  the  banks  of 
the  second  group ;  these  in  turn  kept  part  not  in  cash,  but  in 
the  banks  of  the  first  group.  Hence  there  was  a  great  concen- 
tration of  cash  and  of  responsibility  in  the  last  named,  and  above 
all  in  the  banks  of  New  York  City. 

The  national  banks  of  New  York  —  and  among  them  more 
particularly  a  few  very  large  institutions  which  catered  to  the 
re-deposit  business  of  outside  banks  —  had  come  to  occupy  a 
position  similar  to  that  of  the  Bank  of  England,  being  the 
holders  of  the  really  available  stock  of  free  cash,  and  the  nerve 
center  of  the  whole  sensitive  system.  Some  such  concentration 
in  great  cities  is  inevitable.  In  all  countries,  and  especially 
in  those  where  deposit  banking  is  highly  developed,  every  out- 
lying bank  must  keep  in  touch  with  the  financial  center,  main- 
tain an  account  there,  and  be  prepared  to  effect  payments 
through  it.  In  every  such  center  floating  funds  accumulate, 
—  in  London,  Paris,  Berlin,  Frankfurt,  as  well  as  in  New  York. 
In  every  such  center,  too,  there  are  difficult  problems,  alike  for 
the  banks  themselves  and  for  those  who  have  to  study  the  pub- 
lic's interest,  as  regards  the  use  of  the  floating  funds.  The  banks 
which  are  responsible  for  them,  and  are  subject  to  heavy  and 

1  Forty-seven  in  1913. 


BANKING  SYSTEM  OF  THE  UNITED  STATES      379 

sudden  drafts,  necessarily  try  to  keep  a  large  volume  of  assets 
within  instant  or  easy  command,  —  to  maintain  "liquid  assets," 
as  they  are  called.  A  ready  resort  is  to  demand  loans  secured 
by  stock  exchange  collateral.  In  no  country  were  the  resources 
of  the  metropolitan  banks  thus  used  to  a  more  marked  extent 
than  in  New  York ;  and  the  general  tendency,  which  even  at 
the  best  is  fraught  with  danger,  was  accentuated  in  New  York 
by  the  peculiar  provisions  of  the  national  banking  system  in 
its  older  form. 

All  this  was  greatly  changed  by  the  act  of  1913.  Though 
the  "reserve  city"  and  "central  reserve  city"  banks  retained 
these  designations,  their  place  as  actual  holders  of  a  free  stock 
of  cash  was  taken  by  newly-created  institutions,  — •  the  Federal 
Reserve  Banks.  These  are  quite  different  from  anything  else- 
where in  the  world.  The  endeavor  is  made  to  secure  through 
them  the  advantages  of  centralization  without  centralization 
itself.  Some  radical  reform  in  the  country's  banking  system 
had  been  proved  to  be  absolutely  necessary  by  the  disastrous 
crisis  of  1907;  and  the  first  project  had  contemplated  a  great 
central  institution,  not  fundamentally  unlike  those  of  Europe. 
A  fear  of  the  industrial  and  political  power  of  such  a  huge  bank, 
however,  combined  with  the  particularist  tendency  which  re- 
sults from  our  federated  political  organization,  led  to  the  sub- 
stitution of  this  unique  system;  not  one  central  bank,  but  a 
dozen  semi-centralized  ones. 

The  Federal  Reserve  Banks  are  banker's  banks.  They  are 
owned  by  the  national  banks  (and  by  other  banks,  not  national, 
which  are  given  an  option,  under  suitable  restrictions,  of  joining 
the  system).  These  alone,  no  individuals  or  other  banks  or 
corporations,  are  stockholders  in  the  Reserve  Banks.  And 
the  business  of  the  Reserve  Banks  is  mainly  with  their  owners, 
the  stockholding  banks.  Some  dealings  are  indeed  permitted 
with  non-members,  but  over  a  narrow  range  and  subject  to 
considerable  restrictions.  The  intention  is  that  the  Reserve 
Banks  shall  lend  mainly  to  their  special  banking  constituents. 
More  particularly  they  are  to  take  over  from  these,  by  re-dis- 


380  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

count  or  by  purchase,  commercial  paper.  Thereby  the  banks 
at  large,  which  deal  directly  with  the  general  public,  are  expected 
to  find  their  assets  more  liquid,  being  enabled  to  dispose  of  their 
commercial  paper  before  maturity  and,  if  pressed  for  further 
accommodation,  to  make  advances  to  a  new  set  of  customers. 
The  practice  of  re-discounting,  common  in  European  countries, 
and  the  basis  of  a  very  great  part  of  the  advances  there  made 
by  the  central  banks,  never  had  taken  root  in  the  United  States. 
It  was  expected  and  desired  that  under  the  new  system  a  marked 
change  in  this  regard  should  set  in,  and  a  gain  thereby  secured 
in  the  adjustability  and  serviceability  of  the  whole  complex 
machinery  of  credit.  European  example  and  experience  sug- 
gested this  endeavor.  The  great  public  banks  of  Europe  have 
dealt  comparatively  little  with  the  general  public,  exerting  their 
influence  chiefly  through  other  financial  institutions.  This  was 
most  strikingly  the  case  with  the  Bank  of  France,  hardly  less 
so  with  the  Bank  of  England;  the  Reichsbank  had  cultivated 
somewhat  closer  relations  with  others  than  banks.  The  Reserve 
Banks,  both  in  the  rigidly  restricted  ownership  of  their  stock 
and  the  much  restricted  range  of  their  operations,  were  made 
even  more  pronouncedly  banker's  banks. 

The  Reserve  Banks  became  what  their  name  implies,  — 
holders  of  reserves.  The  several  stockholding  member  banks 
were  required  to  keep  on  deposit  with  them  specified  percent- 
ages of  their  own  demand  deposits.  What  were  the  percentages 
fixed  by  the  act  of  1913  is  shown  in  the  note.1  The  require- 

1  Reserves  required  under  the  Federal  Reserve  Act  of  1913 : 


(a)  For  country  banks 


(6)  For  reserve  city  banks 

(c)  For  the  central  reserve 
city  banks  (New  York, 
Chicago,  St.  Louis) 


4  %  in  own  vaults 

5  %  in  Federal  Reserve  Bank 

3  %  in  one  or  the  other, 

5  %  in  own  vaults 

6  %  in  Federal  Reserve  Bank 

4  %  in  one  or  the  other 

6  %  in  own  vaults 

7  %  in  Federal  Reserve  Bank 

5  %  in  one  or  the  other 


12% 


15% 


18% 


A  transition  period  was  provided  for  in  the  act  of  1913 ;    the  above-stated 
requirements  were  not  to  go  completely  into  effect  until  1917. 


BANKING  SYSTEM  OF  THE  UNITED  STATES     381 

ments  were  made  less  stringent  than  those  of  the  preceding 
national  bank  system.  Thus  the  country  banks,  which  formerly 
had  to  maintain  a  reserve  of  15  per  cent,  were  now  to  maintain 
one  of  12  per  cent;  while,  at  the  other  end  of  the  scale,  the 
central  reserve  city  banks  (among  which  New  York  is  conspicu- 
ous) were  to  keep  but  18  per  cent,  instead  of  25.  And  further, 
the  Reserve  Banks  themselves,  being  banks,  obviously  cannot 
keep  in  cash  the  whole  of  what  is  deposited  with  them.  They 
in  turn  keep  simply  a  reserve  against  the  deposits  from  their 
constituents.  The  law  required  this  reserve  to  be  not  less  than 
35  per  cent.  It  is  to  be  expected  that  the  proportion  will  or- 
dinarily be  higher,  —  perhaps  50  per  cent.  But  in  any  event 
the  actual  cash  available  in  the  required  reserves  is  relatively 
less  than  under  the  old  system. 

This  seems  to  be  a  lessening  of  strength ;  yet  in  fact  it  prob- 
ably is  not  so.  A  bank  reserve  may  be  compared  to  a  con- 
stabulary :  its  effectiveness  depends  less  on  size  than  on  con- 
stant preparedness  for  vigorous  action.  A  moderate  force, 
held  at  central  points,  under  good  discipline  and  leadership, 
easily  turned  where  needed,  can  accomplish  more  than  a  larger, 
scattered,  ill-organized  mass.  The  English  system,  with  no 
very  heavy  reserve  in  the  central  bank,  and  with  hardly  anything 
to  spare  in  the  banks  at  large  beyond  current  requirements, 
nevertheless  has  proved  of  great  strength.  The  Bank  of  Eng- 
land's centralized  store  of  cash  is  always  available  for  prompt 
and  unhesitating  use.  Such  is  expected  to  be  the  case,  and 
should  be  the  case,  with  the  Reserve  Banks.  And  a  still  further 
legislative  proviso  increases  their  ability  to  meet  sudden  re- 
quirements. Authority  is  given  for  certain  new  and  additional 
notes,  which  are  given  a  guarantee  by  the  government;  they 
require  for  their  issues  the  sanction  of  the  Federal  Reserve  Board, 
to  be  presently  described.  The  possibility  of  making  use  of 
them  gives  the  Reserve  Banks  an  extraordinary  and  virtually 
unlimited  resource  on  which  to  fall  back  in  times  of  danger. 

It  is  a  fair  question  whether,  in  view  of  the  centralized  strength 
of  the  Reserve  Banks  and  the  provision  of  extraordinary  re- 


382  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

sources  for  them,  there  is  occasion  for  maintaining  the  tra- 
ditional reserve  requirements  for  the  banks  at  large,  and  es- 
pecially the  requirement  for  keeping  specified  proportions  of 
cash  in  their  own  vaults.  Under  the  old  system  of  almost  com- 
plete decentralization  such  compulsion  was  natural :  there  was 
no  other  way  of  providing  for  the  exigencies  of  strain  and  crisis. 
But  experience  had  shown  such  scattered  reserves  to  be  quite 
ineffective  for  their  main  purpose,  and  this  very  ineffectiveness 
had  been  the  prime  cause  of  the  far-reaching  change  of  system. 
Why  not  now  let  the  several  banks,  under  the  new  arrangements, 
use  their  unfettered  discretion  about  the  cash  to  be  kept  on 
hand?  The  failure  even  to  consider  this  question  is  doubtless 
ascribable  chiefly  to  the  remarkable  conservatism  of  democratic 
legislation.  It  is  true  that  there  may  have  been  good  grounds, 
in  a  system  made  up  of  thousands  of  individual  banks,  most  of 
them  small,  and  few  managed  with  any  large  conceptions  of  pol- 
icy, for  continuing  some  of  the  former  restrictions  on  their  liberty 
of  action.  But  considerations  of  this  kind  were  hardly  mentioned. 
The  retention  of  the  accepted  methods  of  reserve  requirement 
was  due  in  the  main  to  the  singular  tenacity  with  which  Ameri- 
can democracy  clings  to  that  which  is  established  and  familiar. 

A  round  dozen  of  Federal  Reserve  Banks  were  set  up  under 
the  legislation  of  1913,  each  serving  a  so-called  Federal  reserve 
district.  The  Banks  were  designated  by  the  names  of  the  cities 
of  location,1  —  the  Federal  Reserve  Bank  of  Boston,  of  New 
York,  of  Chicago,  and  so  on.  Branch  banks  were  authorized ; 
the  system  ramified  through  the  whole  country. 

§  3.  It  is  obvious  that  we  have  here,  even  more  unequivocally 
than  under  the  old  national  banking  laws,  a  quasi-public  system. 
In  two  ways  public  control  was  emphasized :  first,  in  the  di- 
rectorship and  management  of  the  Reserve  Banks  themselves ; 
second,  and  more  important,  in  the  establishment  of  the  Federal 
Reserve  Board  and  in  the  great  powers  given  to  that  body. 

1  The  twelve  cities  were  Boston,  New  York,  Philadelphia,  Cleveland, 
Richmond,  Atlanta,  Chicago,  St.  Louis,  Minneapolis,  Kansas  City,  Dallas, 
San  Francisco. 


BANKING  SYSTEM  OF  THE  UNITED  STATES     383 

The  Federal  Reserve  Board  is  as  unique  as  any  part  of  this 
novel  system.  It  is  composed  of  seven  persons,  of  whom  the 
Secretary  of  the  Treasury  and  the  Comptroller  of  the  Currency 
are  members  ex  officio  and  the  rest  are  appointed  by  the  Presi- 
dent for  long  terms.  It  has  almost  unlimited  powers  of  control 
over  the  Reserve  Banks,  being  authorized  not  only  to  examine 
all  their  accounts  and  affairs,  but  to  remove  their  officers  and 
directors,  to  require  them  to  re-discount  paper  one  for  another, 
to  suspend  reserve  requirements,  and  "to  exercise  general 
supervision." 

The  directors  of  the  Reserve  Banks  are  partly  appointed 
(three  out  of  a  total  of  nine)  by  the  Federal  Board,  that  is,  by 
public  authority.  One  of  these  is  chairman  of  the  directors,  — 
that  is,  their  presiding  officer ;  not,  it  should  be  observed,  the 
active  managing  head  of  the  Bank,  who  is  chosen  by  the  direc- 
tors and  need  not  himself  be  of  their  number.  The  government 
not  only  thus  retains  a  share  in  the  management ;  it  also  keeps 
a  share  in  the  profits.  All  earnings  over  6  per  cent  on  the 
stock  go  to  the  United  States,  except  that  one-half  is  paid  into 
a  surplus  fund  until  that  amounts  to  40  per  cent  of  the  stock. 

Most  striking  is  the  power  of  the  Board  in  the  matter  of  cir- 
culating notes.  As  was  mentioned  in  the  preceding  section, 
the  Reserve  Banks  may  issue  special  notes,  which  are  virtually 
guaranteed  by  the  government.  They  are  made  by  law  "ob- 
ligations of  the  United  States,"  and  are  redeemable,  at  the 
holder's  option,  at  the  United  States  Treasury.  But  they  may 
be  issued  only  on  application  to  the  Federal  Reserve  Board  and 
subject  to  its  approval.  Complete  discretion  is  given  to  the 
Board ;  there  is  no  limitation  either  as  regards  the  amount  of 
the  notes  or  the  conditions  which  shall  justify  them.  The 
Reserve  Banks  themselves,  it  is  true,  must  conform  to  certain 
requirements ;  they  must  deposit  with  the  agents  of  the  Board 
security  for  the  notes  in  the  way  of  commercial  paper,  and  they 
must  keep  a  reserve  of  40  per  cent  in  gold  against  them.  But 
subject  to  the  fulfillment  of  these  requirements  by  the  Banks, 
the  Board  itself  may  do  as  it  sees  fit ;  may  refuse  to  sanction 


384  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

notes  at  all,  may  sanction  few  or  many,  may  compel  the  Banks 
to  pay  interest  on  the  notes  at  any  rate  it  establishes  or  no 
interest  at  all.  These  new  pieces  of  paper  money  are  known  as 
"Federal  reserve  notes" ;  they  are  quite  distinct  from  the  old 
national  bank  notes  and  from  possible  successors  to  these  which 
may  arise  through  the  contemplated  gradual  transfer  of  the  more 
normal  note-issue  function  to  the  Reserve  Banks.  They  are 
an  issue  without  precedent  in  every  regard. 

Two  contingencies  were  doubtless  had  in  mind  as  likely  to 
warrant  the  issue  of  Federal  reserve  notes.  One  is  recurrent : 
the  seasonal  variation  in  the  occasion  for  money  payments, 
especially  in  the  agricultural  regions  of  the  West  and  South. 
To  "move  the  crops"  was  long  and  will  long  remain  a  special 
monetary  task,  and  one  which  the  old  national  banking  system 
had  never  performed  satisfactorily.  A  second  contingency  is 
that  of  a  crisis,  —  the  sudden  demand  for  cash  which  is  apt  to 
spring  up  from  a  threatened  general  collapse.  On  both  of  these 
possible  needs  more  is  said  in  the  next  chapter ;  for  both  there  is 
provided  an  extraordinary  resource. 

§  4.  In  one  important  respect  banking  habits  and  the  banking 
system  are  peculiar  in  the  United  States,  —  in  the  great  number 
of  individual  banks  and  the  almost  complete  absence  of  branches. 
In  most  of  the  advanced  countries,  general  credit  operations  are 
carried  on  chiefly  by  a  comparatively  small  number  of  banks, 
each  of  them  large  and  each  having  many  branches.  This  is 
particularly  true  of  Great  Britain  and  Canada.  In  the  United 
States  branch  banking  is  virtually  unknown.  Thousands  of 
banks,  scattered  all  over  the  country,  go  their  ways  independ- 
ently. This  situation  is  due  in  part  to  legislation  prohibiting 
or  restricting  branches ;  but  the  legislation  itself  reflects  deep- 
se'ated  habits  and  traditions.  A  prejudice  against  large-scale 
institutions,  as  tending  to  monopoly,  also  in  part  accounts  for 
it.  Still  other  important  factors  are  the  federated  political 
system  and  the  strength  of  local  feeling.  At  all  events,  there 
is  a  decentralization  in  management  even  more  marked  than 
that  in  the  former  system  of  note  issue  and  of  deposits. 


BANKING   SYSTEM   OF   THE   UNITED   STATES     385 

This  situation  is  rendered  the  more  pregnant  with  danger 
because  of  the  existence  side  by  side  of  two  great  aggregations : 
multitudes  of  state  banks  side  by  side  with  the  national  banks. 
The  state  banks  —  meaning  by  that  term  all  the  banking  in- 
stitutions outside  the  national  system,  including  "trust  com- 
panies" as  well  as  those  calling  themselves  banks  —  have  been 
almost  as  large  a  factor  as  the  other  group.  During  the  first 
decade  of  the  present  century  the  total  deposits  of  the  two  were 
nearly  the  same.  But  the  state  banks  conduct  their  business 
under  supervision  which  is  necessarily  less  uniform  than  that  for 
national  banks  and  in  general  is  less  stringent  and  effective. 
Although  in  some  jurisdictions  there  are  good  banking  laws 
well  administered,  in  many  others  the  financial  institutions  are 
allowed  to  do  much  as  they  please. 

The  extraordinary  scattering  of  banking  institutions  and  re- 
sources is  not  without  its  advantages.  Competition  between 
the  innumerable  banks  has  much  promoted  the  permeation  of 
the  country  with  credit  facilities.  Nowhere  in  the  world  have 
banking  facilities  been  so  widely  used.  And  this  situation  is 
likely  to  continue.  There  will  remain  for  an  indefinite  period 
a  conglomeration  of  very  numerous  and  very  different  institu- 
tions, —  state  banks  as  well  as  national  banks,  great  city  banks 
and  petty  country  banks,  strictly  commercial  banks,  financing 
corporations,  banks  serving  mainly  the  agricultural  constituen- 
cies, —  all  dealing  with  each  other,  yet  all  likely  to  go  their 
ways  in  ordinary  times  with  complete  disregard  of  each  other's 
safety. 

Into  this  fairly  chaotic  situation  the  Federal  Reserve  law 
endeavored  to  introduce  some  order  and  concatenation. 
It  was  planned  to  strengthen  the  entire  system,  indirectly  not 
less  than  directly.  Yet  the  final  consequences  are  quite  im- 
possible to  foretell;  and  the  organization  of  banking  in  the 
United  States  may  still  see  as  great  changes  in  the  first  half  of 
the  twentieth  century  as  it  saw  in  the  second  half  of  the  nine- 
teenth. 


CHAPTER  28 
PROBLEMS  OF  LEGISLATION  ON  BANKING 

§  1.  Some  of  the  more  important  problems  as  to  legislation 
may  now  be  considered,  in  the  light  of  the  preceding  discussion 
of  the  theory  of  banking  and  the  characteristics  of  leading  bank- 
ing systems. 

It  is  clear  that  there  is  universally  provision  of  some  sort  for 
the  special  security  of  bank  notes.  This  is  strikingly  the  case 
in  the  legislation  of  England  and  of  the  United  States ;  hardly 
less  so  elsewhere.  On  the  Continent  the  general  prevalence  of 
monopoly  issue  has  in  practice  the  same  effect.  Notes  may 
be  issued  only  by  central  banks,  backed  by  the  state  and  no  less 
solvent  than  the  state  itself.  On  the  other  hand,  special  pro- 
vision for  the  security  of  deposits  is  rare.  The  legislation  of  the 
United  States  stands  almost  alone  in  its  requirements  as  to 
reserves  and  the  like ;  and  even  here  the  protection  of  the  de- 
positors is  safeguarded  much  less  rigidly  than  that  of  the  note 
holders.  Is  this  difference  in  the  treatment  of  the  two  sorts  of 
obligation  reasonable  ? 

No  doubt,  the  difference  has  rested  historically  on  the  fact  that 
the  similarity  between  notes  and  deposits  has  not  been  per- 
ceived. Though  deposits  subject  to  check  form  part  of  the  circu- 
lating medium  quite  as  much  as  notes  do,  and  indeed  are  quan- 
titatively much  more  important  in  countries  like  Great  Britain, 
the  United  States,  and  Canada,  they  are  not  commonly  regarded 
as  "money";  yet  notes  are  so  regarded.  But  though  the 
special  protection  to  note  holders  is  explained  in  this  way,  it 
must  be  justified,  if  at  all,  on  other  grounds. 

The  grounds  for  giving  special  security  to  note  holders  are  two. 
In  the  first  place,  notes  are  more  likely  to  be  held  by  the  poorer 
and  dependent  classes.  Deposits  are  used  chiefly  by  the  well- 
to-do.  Notes  circulate  among  all  classes,  and  notes  of  the  smaller 

386 


PROBLEMS  OF  LEGISLATION  ON  BANKING       387 

denominations  are  likely  to  be  in  the  hands  of  workmen  and  others 
of  slender  means.  Next,  and  not  less  important,  is  the  difference 
in  the  way  in  which  a  person  becomes  creditor  of  the  bank.  A 
depositor  almost  always  becomes  creditor  by  his  own  choice; 
a  note  holder  commonly  becomes  so  without  any  volition  of  his 
own,  and,  moreover,  by  a  process  of  whose  legal  import  he  usu- 
ally knows  nothing.  A  note  circulates  from  hand  to  hand  as 
"money."  The  person  to  whom  it  is  offered  in  payment  would 
commonly  find  difficulty  in  refusing  it.  Ordinarily  he  is  quite 
unaware  that,  in  taking  it  thus  freely,  he  is  simply,  in  the  eye  of 
the  law,  replacing  another  person  as  creditor  of  the  issuing 
bank.1  Who  are  the  note-holding  creditors  at  any  given  time  is 
a  matter  of  accident ;  since  each  person  receiving  a  note  keeps  it 
until  he  has  occasion  to  use  it  in  a  purchase.  Depositors,  on  the 
other  hand,  select  their  bank  with  some  deliberation.  No  doubt, 
they  are  often  influenced  by  the  bank's  mere  propinquity  or  by 
its  general  reputation.  None  the  less,  the  initiative  comes  from 
them,  and  the  first  responsibility  is  theirs. 

These  distinctions,  however,  must  not  be  pressed  too  far,  nor 
permitted  to  obscure  the  fundamental  point  of  resemblance,  — 
that  deposits,  like  notes,  constitute  part  of  the  de  facto  circulat- 
ing medium.  The  same  fundamental  reasons  which  make  it 
important  that  notes  should  be  secure,  make  it  important  that 
deposits  should  be  secure.  The  essential  question  concerns  the 
expedient  ways  of  promoting  security. 

1  The  legal  position  of  the  payee  of  a  check  is  different  from  that  of  the  holder 
of  a  bank  note.  The  payee  of  the  check  does  not,  like  the  note  receiver,  become 
at  once  a  creditor  of  the  bank.  The  bank's  liability  is  only  to  the  drawer  of 
the  check  (the  depositor) .  If  the  bank  refuses  to  pay  the  check  when  presented, 
the  depositor  only,  not  the  payee,  has  a  right  of  action  against  it.  On  the  other 
hand,  the  sending  of  a  check  in  payment  of  a  debt  does  not  at  once  liquidate 
the  debt.  Should  the  bank  fail,  or  for  any  reason  refuse  to  pay  the  check,  the 
debtor  who  has  sent  it  is  still  liable.  If,  indeed,  the  payee  of  a  check  fails  to 
take  steps  with  reasonable  diligence  for  its  presentation  at  the  bank  on  which 
drawn,  the  legal  situation  becomes  different.  If  he  puts  the  check  away,  and 
waits  unduly  before  presenting  it,  he  substitutes  himself  for  the  drawer  as  cred- 
itor of  the  bank.  Failure  of  the  bank  in  the  interval  then  means  loss  to  him,  not 
to  the  bank's  original  creditor  (depositor).  Hence  the  business  practise  of 
always  sending  all  checks  received  for  immediate  "deposit,"  i.e.  for  collection 
at  the  clearing  house,  through  one's  own  bank.  By  this  process  the  receiver  of 
a  check  makes  himself  as  promptly  as  possible  a  creditor  of  his  own  bank. 


388       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

In  the  legislation  of  the  United  States,  at  least,  the  principle  of 
providing  in  some  way  for  the  protection  of  depositors  is  too 
firmly  established  to  be  open  to  question.  It  shows  itself  not 
only  in  those  requirements  as  to  reserves  which  have  already 
been  noticed,  but  in  a  whole  code  of  banking  legislation.  The 
nature  of  the  loans  which  a  national  bank  may  make  is  rigidly 
defined.  Not  only  in  the  national  bank  laws,  but  in  those  of  the 
states,  there  is  regulation  of  the  extent  of  loans  to  any  one  in- 
dividual, of  loans  to  directors,  and,  not  least,  provision  for  pub- 
licity of  accounts  and  periodical  examination.  The  Comptroller 
of  the  Currency  at  Washington  has  a  staff  of  examiners,  and 
large  powers  over  the  national  banks ;  the  several  states  either 
have  similar  bureaus  for  their  own  banks,  or  are  moving  toward 
such  supervision. 

All  this  regulation  is  unique  in  the  United  States.  Just  as  the 
requirement  as  to  cash  reserves  for  deposits  is  unknown  else- 
where, so  is  all  the  detailed  regulation  of  loans,  reports,  and 
special  liabilities  of  officers  and  directors.  The  situation  is  a 
curious  one.  In  a  country  where  the  general  tradition  has  been 
to  let  capitalistic  industry  pursue  its  course  unfettered,  the  very 
center  of  capitalist  operations  has  been  subjected  to  a  degree  of 
control  undreamed  of  in  other  countries.  The  cause  of  this 
remarkable  extension  of  state  interference  is  to  be  found  partly 
in  the  early  development  and  wonderful  spread  of  deposit  bank- 
ing, but  still  more  in  an  underlying  dim  consciousness  that  here 
was  really  a  most  important  and  far-reaching  part  of  the  cir- 
culating medium.  Once  the  system  is  fully  established,  no 
individual  can  keep  out  of  it.  It  is  indispensable  that  he  have 
his  bank  of  deposit  and  his  bank  account.  And  though  he  may 
choose  his  own  bank,  and  may  be  supposed  to  be  on  the  watch  as 
to  its  character  and  solvency,  his  means  of  getting  information 
are  necessarily  uncertain.  The  public  concern  in  banking, 
which  at  first  was  chiefly  for  the  security  of  notes,  has  come  to  be 
no  less  for  their  equally  pervasive  and  far  more  powerful  suc- 
cessors, the  deposits. 

Hence  the  proposal  that  deposits  should  be  made  absolutely 


PROBLEMS  OF  LEGISLATION  ON  BANKING        389 

safe,  like  notes,  is  not  an  illogical  or  revolutionary  one.  Ob- 
viously, no  method  of  segregation  of  particular  assets  (such 
as  is  used  in  regard  to  notes  by  the  national  banking  system)  can 
suffice  for  the  purpose ;  since  the  only  possible  security  for  all 
deposits  would  be  the  solidity  of  all  assets.  The  only  feasible 
method  is  one  of  insurance,  —  compulsory  contribution  by 
every  bank  to  a  public  (or  publicly  supervised)  guarantee  or- 
ganization, out  of  which  the  deposits  of  a  collapsed  bank  would 
be  met ;  an  application  to  deposits,  in  other  words,  of  a  system 
like  that  of  Canada  for  notes.  The  main  objection  to  this  pro- 
posal is  that  one  great  safeguard  —  perhaps  the  greatest  safe- 
guard —  against  reckless  banking  would  be  removed.  This  is 
the  banker's  fear  of  the  depositor.  Though  his  legal  obligation 
to  meet  deposit  liabilities  on  demand  would  indeed  remain,  the 
probability  of  the  presentation  of  demands  would  be  greatly 
diminished.  If  every  depositor  knew  that  his  "  money  "  was  sure 
to  be  forthcoming  in  any  case,  being  guaranteed  by  the  state 
or  other  adequate  organization,  pressure  on  a  bank  from 
uneasy  depositors  would  be  less  likely  to  follow  suspicious 
doings.  A  bank  might  pursue  a  reckless  course  for  an  indefinite 
time,  or  at  least  for  a  longer  time  than  if  the  confidence  of  the 
depositor  needed  to  be  constantly  nurtured. 

This  objection,  though  strong,  is  not  necessarily  conclusive. 
Reckless  banking  takes  place  now,  even  under  the  eye  of  the  un- 
guaranteed depositor.  If  the  guarantee  were  one  not  of  imme- 
diate payment,  but  only  of  ultimate  payment,  —  if  the  depos- 
itor, though  secured  from  eventual  loss,  were  still  subject  to  the 
possible  inconvenience  of  having  his  funds  "tied  up"  for  a  time 
in  a  liquidating  bank,  —  it  would  still  be  to  his  interest  to  be 
watchful  and,  when  suspicious,  to  withdraw  his  account.  The 
strong  interest  which  stockholders  have  in  prudent  management 
would  continue  to  be  a  check  on  recklessness.  The  course  of 
legislation  on  this  matter,  as  on  others,  is  likely  to  be  much 
affected  by  actual  experience.  A  succession  of  conspicuous 
bank  failures,  bringing  great  loss  to  depositors,  would  immensely 
strengthen  the  movement  for  deposit  guarantee.  Then  meas- 


390        MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

ures  which  now  seem  beyond  the  range  of  practicability  might 
be  found  feasible  after  all. 

§  2.  Much  has  been  said  in  recent  discussion  in  the  United 
States  about  the  need  of  elasticity  in  the  currency,  and  especially 
in  the  bank  notes. 

Most  persons  who  speak  and  write  on  this  topic  have  very 
confused  notions  of  the  grounds  on  which  elasticity  is  desirable. 
They  think,  as  a  rule,  only  of  elasticity  upwards,  —  of  a  system 
under  which  the  money  supply  will  expand  freely  and  indefi- 
nitely. Most  business  men  and  most  financial  writers  of 
the  daily  and  weekly  press  are  (unconsciously)  inflationists. 
Though  usually  opposed  to  such  inflation  as  brings  obvious  de- 
preciation, they  welcome  plentifulness  of  money  and  rising 
prices;  this  "makes  business  good." 

The  general  feeling  in  favor  of  easy  expansion  is  promoted  by 
failure  to  distinguish  between  an  elastic  currency  and  an  "emer- 
gency" currency.  As  will  appear  presently,1  there  are  times  of 
crisis  when  a  potential  increase  in  the  money  supply  may  be  of 
high  service,  such  as,  for  example,  the  possible  increase  of 
Bank  of  England  notes  after  a  suspension  of  the  Bank  Act.  But 
the  need  for  this  sort  of  expansion  is  infrequent  and  usually  of 
short  duration;  indeed,  under  a  well-devised  and  well-tested 
banking  system,  such  a  need  hardly  exists.  At  all  events,  the 
concern  of  the  community  in  emergency  issues  is  very  different 
from  that  which  it  has  in  a  currency  elastic  with  reference  to  the 
recurring  ordinary  fluctuations  of  industry. 

An  elastic  currency  is  really  desirable  on  two  grounds :  first, 
adaptation  to  normal  variations  in  transactions;  second,  com- 
pleter  supply  of  credit  facilities  to  those  likely  to  make  good  use 
of  capital. 

The  typical  case  of  normal  variation  in  the  demand  for 
money  appears  in  harvest  times, — the  inevitable  compressing  of 
transactions  when  the  crops  are  garnered.  The  farmers  must 
then  pay  extra  laborers,  and  later  must  themselves  be  paid  by 
merchants  and  middlemen.  In  almost  all  countries  there  is  an 

1  See  Chapter  30,  on  Financial  Crises. 


PROBLEMS  OF  LEGISLATION  ON  BANKING        391 

autumnal  drain  on  the  money  market ;  the  available  supplies 
of  cash,  held  chiefly  by  banks,  are  more  heavily  drawn  on  at 
this  season.  In  a  country  predominantly  agricultural,  as  the 
United  States  still  is,  the  drain  is  especially  marked.  The 
flow  of  money  to  the  West  and  South,  "to  move  the  crops,"  is 
a  familiar  annual  phenomenon.  There  is  occasion  for  an  expan- 
sion of  money  in  proportion  to  this  seasonal  increase  of  trans- 
actions, and  for  contraction  afterward.  Freely  issued  bank 
notes  might  meet  the  need,  being  put  out  as  loans  to  dealers  and 
farmers  at  the  harvest  season,  and  returned  to  the  banks  of 
issue,  through  a  quasi-automatic  process,  at  the  close  of  the 
season. 

The  second  gain  from  an  elastic  note  issue,  that  of  wider  ex- 
tension of  credit  facilities,  is  important  in  proportion  as  the  ex- 
tension of  banking  in  general  is  dependent  on  the  use  of  notes. 
This  gain  alone  justifies  our  modern  practise  of  leaving  to 
private  hands  the  supply  of  so  important  a  constituent  of  the 
circulating  medium.  Were  it  not  that  commercial  banking  pro- 
motes the  extension  of  credit  and  of  capital  to  capable  managers 
of  the  productive  forces,  both  note  issue  and  deposit  banking 
would  rightly  be  public  operations  once  for  all.  In  countries 
where  notes  are  the  main  form  of  ban-k  credit,  elastic  issue  is  of 
prime  importance  in  promoting  greater  continuity  and  more 
ready  enterprise  in  business  operations.  These  advantages  are 
likely  to  be  secured  to  a  greater  degree  by  competing  banks 
than  by  a  monopoly  bank ;  but  they  are  in  either  case  secured 
more  readily  from  elastic  issue  than  from  rigidly  regulated  issue. 

Neither  gain  from  elasticity  of  issue  was  secured  by  our  na- 
tional banking  system.  The  banks  did  not  accommodate 
their  issues  to  seasonal  variations,  because  the  issue  of  notes 
depended  in  the  first  instance  on  the  profit  obtainable  by  buying 
government  bonds  and  issuing  notes  against  them.  It  was 
often  said  that  the  issue  of  national  bank  notes  had  no  relation 
whatever  to  the  community's  monetary  needs,  and  depended 
solely  on  the  current  price  and  current  interest  return  of  govern- 
ment bonds.  This  was,  in  my  judgment,  an  overstatement  of 


392  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

the  case;  on  the  whole,  and  in  the  long  run,  the  volume  of 
national  bank  notes  did  adapt  itself  to  the  changing  extent  of 
the  needs  for  circulation.  But  it  is  true  that  these  issues  had 
no  elasticity  over  short  periods. 

The  national  bank  system  never  proved  suited  to  the  condi- 
tions of  the  strictly  agricultural  parts  of  the  United  States,  and 
never  brought  about  any  adequate  extension  of  credit  facilities 
for  them.  Some  part  of  this  failure  was  due  to  the  industrial 
conditions  of  newer  regions ;  no  system  of  cautious  banking  is 
adapted  to  places  of  undeveloped  industries  and  uncertain 
future.  The  problem  of  agricultural  credit  is  a  peculiar  and 
difficult  one,  above  all  in  the  United  States,  and  it  is  not  easy 
to  say  what  sort  of  banking  system  best  meets  our  needs. 
Needs  there  are,  as  is  shown  by  the  extraordinary  number  of 
small  state  banks  in  the  Mississippi  and  Missouri  valleys ;  and 
this  development  of  banks  outside  the  national  system  shows 
also  that  the  system  itself  was  inadequate.  There  was  ground 
for  saying  that  a  more  elastic  sort  of  issue,  if  properly 
safeguarded,  would  promote  the  extension  of  good  credit 
facilities. 

But  these  considerations,  both  as  to  adaptability  and  per- 
meation, have  come  to  be  in  recent  years  of  much  less  im- 
portance in  the  United  States,  because  of  the  steady  extension 
of  deposit  banking.  Deposits  are  ideally  elastic.  They  ex- 
pand and  contract  under  the  very  influences  that  lead  to 
expansion  and  contraction  in  the  volume  of  transactions.  It 
cannot  be  said  that  they  vary  in  precise  proportion  to  trans- 
actions, —  if  they  did,  fluctuations  in  the  general  level  of 
prices  would  be  less  than  in  fact  they  are.  They  seem  to  ex- 
pand more  sharply  and  to  contract  more  sharply  than  the  trans- 
actions with  which  they  show  general  sympathy.  But  elastic 
they  certainly  are,  —  it  is  their  great  virtue,  though  also 
their  great  potential  evil.  They  promote  in  the  highest 
degree  activity,  continuity,  flexibility,  in  business  operations. 

Jt  follows  that  in  deposit-using  countries  the  question  of 
elasticity  with  reference  to  bank  notes  by  themselves  is  not  of 


PROBLEMS  OF  LEGISLATION  ON  BANKING        393 

the  first  importance.  People  lay  undue  stress  on  note  issue, 
partly  because  of  the  confusion  with  emergency  issues,  partly 
because  they  fail  to  understand  that  deposits  stand  side  by 
side  with  notes  as  part  of  "bank  money."  In  a  thickly  settled 
manufacturing  country  like  Great  Britain,  deposits  give  all 
the  elasticity  needed ;  hence  the  rigid  note  system  of  England 
causes  no  appreciable  inconvenience.  Though  the  case  is 
different  in  agricultural  regions  like  Canada  and  our  Western 
states,  yet  in  almost  all  parts  of  the  United  States,  including 
the  great  farming  districts,  deposit  banking  has  shown  an 
extraordinary  growth  in  recent  years,  and  a  remarkable  capacity 
for  meeting  the  needs  of  a  scattered  population  with  pulsating 
industries.  There  are  still,  and  will  always  be,  variations  in 
the  demand  for  hand-to-hand  money  in  the  form  of  specie  or 
notes;  and  there  are  therefore  grounds  for  advocating  con- 
ditions of  note  issue  essentially  different  from  those  of  the 
national  bank  system.  But  the  need  is  not  so  imperative  as  is 
often  supposed.  A  certain  degree  of  elasticity  —  of  accom- 
modation to  varying  demands  —  is  inherent  in  any  highly 
developed  medium  of  exchange,  even  though  it  be  specie  alone. 
Elasticity  of  note  issue  in  the  United  States  is  desirable,  but 
is  not  of  the  first  importance ;  least  of  all  is  it  a  panacea  for 
monetary  and  industrial  disturbances. 

§  3.  What  is  to  be  said,  finally,  of  the  advantages  of  cen- 
tralized note  issue  compared  with  decentralized,  and  what 
conclusion  can  be  stated?  To  these  questions,  no  unqualified 
answer  can  be  given.  Much  depends  on  historical  and  po- 
litical conditions,  on  tradition,  habit,  and  economic  develop- 
ment, in  the  several  countries.  The  English  system  works  well 
in  Great  Britain,  the  French  in  France,  the  German  in  Germany. 
It  does  not  follow  that  any  of  them,  if  transplanted  to  the 
United  States,  would  work  well  here. 

So  far  as  security  is  concerned,  there  is  no  ground  for  pre- 
ferring centralized  to  decentralized  issue.  This  at  least  is  the 
case  where  notes  are  issued  by  banks  which  also  carry  on  other 
banking  operations  and  more  particularly  conduct  a  deposit 


394       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

business.  By  giving  notes  a  prior  lien  on  the  assets,  and  by 
a  guarantee  fund  (as  in  the  Canadian  system),  the  security  of 
the  notes  can  be  made  absolute,  and  their  holders  protected 
infallibly  from  loss.  Where,  indeed,  a  bank  carries  on  the 
function  of  issue  solely,  and  where  virtually  all  of  its  liabilities 
are  thus  in  the  form  of  notes,  such  safeguarding  is  more  diffi- 
cult, —  it  involves  provision  for  the  solidity  of  all  the  assets 
of  the  bank.  In  English-speaking  countries,  however,  note 
issue  always  forms  a  minor  part  of  the  credit  operations  of  a 
commercial  bank.  Hence  notes  can  be  made  safe  without  the 
state's  undertaking  minute  supervision  of  all  the  bank's  operations. 

None  the  less,  centralized  issue  under  government  manage- 
ment (direct  or  indirect)  means  more  certain  and  unquestion- 
able safety,  —  safety  as  great  as  that  of  the  government  itself. 
No  doubt,  there  is  the  danger  that  public  banks  will  be  made 
agents  for  the  issue  of  inconvertible  paper  money.  But  this 
danger  is  not  greater  than  that  of  the  direct  issue  of  such 
money  by  the  government  itself;  and  the  prospects  of  the 
eventual  resumption  of  specie  payments  are  at  least  as  good 
for  bank  notes  as  for  government  notes. 

The  pecuniary  profit  which  the  public  can  secure  from 
monopolized  issue  is  a  minor  matter.  That  profit  may  be  either 
direct,  as  when  the  government  shares  in  all  dividends  on 
capital  above  a  certain  amount  (for  example,  in  Germany  and 
Switzerland),  or  indirect,  as  when  the  bank  gives  its  services 
gratis  for  managing  the  public  debt  and  the  public  finances 
(for  example,  in  England  and  France).  But  the  profit  is  never 
a  considerable  item  in  the  public  budget,  and,  such  as  it  is, 
might  be  secured  in  even  greater  amount  through  the  simple 
device  of  convertible  money  issued  directly  by  the  government. 
The  stability  and  serviceability  of  the  circulating  medium,  and 
the  effects  which  its  mode  of  issue  has  upon  the  industries  of 
the  community,  are  mainly  to  be  considered.  Compared  with 
these  vital  matters,  the  profit  to  a  government  from  one  way 
or  another  of  dealing  with  the  money  supply,  whether  specie 
or  paper,  is  a  negligible  matter. 


PROBLEMS  OF  LEGISLATION  ON  BANKING        395 

The  deciding  considerations  (at  least,  those  of  a  strictly 
economic  character)  would  seem  to  refer  on  the  one  hand  to 
the  mitigation  of  crises,  and  on  the  other  to  the  services  which 
banking  institutions  render  in  ordinary  times.  It  happens 
that  these  considerations  tell  in  opposite  directions.  A  central 
bank  is  the  better  agent  for  dealing  with  crises.  A  decentralized 
system  promotes  more  effectively  the  wide  extension  of  bank- 
ing facilities. 

The  mode  in  which  a  central  bank  can  give  support  in  times 
of  panic  will  be  more  fully  explained  in  the  second  following 
chapter.1  Its  services  on  such  occasions  constitute  probably 
its  greatest  economic  advantage,  at  least  for  a  country  like 
England  or  the  United  States.  Though  it  cannot  prevent  alter- 
nations of  industrial  excitement  and  lethargy,  of  good  times 
and  bad  times,  it  may  mitigate  the  range  of  the  oscillations, 
and  give  inestimable  aid  at  the  critical  stage  of  an  acute  panic. 
At  just  this  point  the  former  decentralized  banking  system  of 
the  United  States  was  most  open  to  criticism.  It  broke  down 
completely  in  times  of  stress,  not  once,  but  repeatedly,  —  so 
often  that  a  remedy  of  some  sort  was  imperative.  Whether  a 
remedy  will  be  found  in  the  Federal  Reserve  system  established 
in  1913  is  not  certain;  but  unless  so,  this  consideration  alone 
would  be  almost  decisive  in  favor  of  a  central  bank. 

In  favor  of  decentralized  issue  is  the  likelihood  of  a  more 
active  and  abundant  provision  of  banking  facilities,  and  so  of  a 
more  effective  utilization  of  the  community's  resources.  Com- 
peting banks,  actuated  by  the  motive  of  profit,  are  more  effec- 
tive agents  to  this  end  than  a  monopoly  bank ;  they  have  the 
advantages  which  private  management  commonly  has  over 
public.  They  reach  out  to  get  business  instead  of  waiting  for 
business  to  come  to  them.  The  more  enterprising  the  manage- 
ment of  a  monopoly  bank,  the  less  does  this  argument  tell  in 
favor  of  decentralization.  Both  the  Bank  of  France  and  the 
Reichsbank  have  proceeded  with  energy  during  the  last  thirty 
years  in  adding  to  the  number  of  their  branches  and  in  extend- 

» Chapter  30. 


396   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

ing  their  operations.  None  the  less,  they  still  remain  chiefly 
banker's  banks.  They  use  the  private  bankers  as  middlemen 
for  ascertaining  the  needs  of  borrowers,  for  scrutinizing  their 
projects  and  business  ability,  for  guaranteeing  their  solvency. 
Such  middlemen's  services  are  not  to  be  had  gratis;  they  are 
paid  for  in  the  rates  of  discount  charged  to  the  borrowing  public. 

The  argument  that  non-monopoly  issue  conduces  to  the 
flexible  extension  of  credit  facilities,  is  important  according  to 
the  degree  in  which  the  facilities  are  dependent  on  this  form 
of  bank  credit.  It  has  already  been  pointed  out  that  in  the 
United  States,  where  banking  is  most  decentralized,  note 
issue  is  declining  in  importance.  The  extraordinary  spread  of 
deposit  banking  has  relegated  it  to  a  minor  place  in  banking 
operations.  Country  districts,  thinly  settled  and  not  in  quick 
communication  with  financial  centers,  have  been  supposed  the 
best  field  for  credit  extension  in  the  form  of  notes.  Hence  it 
is  often  thought  that  the  great  agricultural  regions  of  the 
United  States  would  benefit  most  from  free  and  flexible  issue. 
But  the  perfection  of  mail  arrangements  has  conduced  to  the 
use  of  deposits  and  checks  in  every  nook  and  cranny.  The 
whole  problem  of  banking,  in  its  connection  with  the  ready 
extension  of  credit  for  industrial  operations,  has  become  very 
different  from  what  it  was  fifty  years  ago.  The  national  bank- 
ing system,  even  in  its  best  days,  was  not  well  devised  for 
meeting  the  needs  of  the  agricultural  parts  of  the  United 
States.  The  wonderful  growth  of  state  banks  in  the  West, 
having  no  right  of  issue,  indicates  that  this  right  is  not  essen- 
tial to  a  permeation  of  the  country  by  banking  facilities.  Regu- 
lation of  note  issue,  whether  through  a  central  bank  or  through 
supervision  of  scattered  banks,  is  now  much  less  important 
than  the  strengthening  of  the  vast  and  top-heavy  structure  of 
deposits. 

§  4.  Like  all  questions  which  are  chiefly  of  an  economic 
sort,  this  one  has  its  other  aspects  also,  —  fiscal  and  political ; 
and  these  often  are  difficult  to  separate  from  the  purely  economic 
aspects. 


PROBLEMS  OF  LEGISLATION  ON  BANKING        397 

A  central  bank  has  obvious  fiscal  advantages  for  the  govern- 
ment. It  may  be  of  great  service  in  the  course  of  ordinary 
financial  operations,  of  even  greater  service  in  times  of  public 
stress.  It  acts,  in  the  countries  where  the  system  is  established, 
as  the  regular  custodian  of  the  public  funds.  In  times  of  war 
or  other  emergency,  it  can  afford  powerful  aid,  putting  all  its 
resources  in  the  extreme  case  at  the  disposal  of  the  gov- 
ernment. Both  of  these  advantages  have  strongly  influenced 
the  establishment  of  the  great  public  banks  of  Europe.  So 
far  as  concerns  the  United  States,  the  relations  between  a 
central  bank  and  the  central  government  would  present  ad- 
ministrative and  fiscal  problems  of  unusual  complexity,  because 
of  the  extraordinary  irregularity  of  our  government's  receipts 
and  disbursements.  To  enter  on  this  intricate  matter  is  beyond 
the  scope  of  the  present  book ;  suffice  it  to  say  that  the  possible 
services  and  the  possible  difficulties  of  a  central  bank  are, 
from  a  fiscal  point  of  view,  equally  great,  and  that  the  attain- 
ment of  a  balance  of  clear  gain  would  depend  on  the  unpredic- 
table element  of  management  at  once  skillful  and  high-minded. 

On  the  purely  political  side,  there  are  unquestionably  grave 
possibilities  of  harm.  The  character  of  the  management  is  of 
the  utmost  importance ;  and  this  depends  not  only  on  formal 
organization,  —  on  the  powers  which  the  government  and  the 
stockholders  have  in  selecting  the  managers,  —  but  on  political 
and  industrial  traditions. 

The  first  and  second  Banks  of  the  United  States  (1791-1811 
and  1817-1837)  became  entangled  in  the  political  controversies 
of  their  times,  and  so  became  impossible  as  controllers  of  credit 
and  industry.  The  lesson  was  long  supposed  to  show  con- 
clusively that  we  in  the  United  States  cannot  keep  such  an 
institution  "out  of  politics,"  and  therefore  must  forego  the 
advantages  which  it  may  offer.  To  many  men  of  the  business 
class  this  objection  still  appears  insuperable;  just  as  it  does 
with  regard  to  government  ownership  of  telegraphs,  railways, 
and  other  so-called  public  industries.  The  trend  of  opinion, 
however,  is  unmistakably  toward  public  control  in  many 


398        MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

directions,  and  toward  experiments  in  the  direction  of  public 
ownership.  A  central  bank  does  not  appear  as  impossible  as 
it  did  a  generation  ago.  Obviously,  no  lasting  benefits  to  the 
community  could  be  got  unless  it  were  in  the  hands  of  a  staff 
of  trained  and  capable  officials,  independent  of  current  political 
movements,  aloof  from  popular  clamor,  having  permanent 
tenures  and  dignified  positions.  Their  posts  must  be  such  as 
to  enlist  ability  of  the  first  order.  Here  is  the  gravest  problem 
of  democracy.  Administrative  efficiency  is  the  sine  qua  non 
of  any  extension  of  government  functions.  No  one  is  entitled 
to  speak  with  assurance  of  the  way  in  which  the  American 
people  will  meet  this  need.1  Yet  efficient  management  can  per- 
haps be  expected  in  a  bank  more  confidently  than  in  other 
directions,  since  the  operations  directly  touch  the  business 
class  alone.  How  far  complete  divorce  from  political  influence 
can  be  secured,  is  impossible  of  prediction. 

Not  less  important  than  the  question  of  political  pressure  is 
that  of  business  pressure.  To  serve  its  purposes,  a  bank 
should  be  conservative  as  well  as  powerful.  It  should  offer  aid 
freely  to  the  business  community  in  times  of  danger  and  panic, 
but  should  hold  aloof  in  times  of  speculation  and  inflation. 
That  which  would  probably  be  its  greatest  service  in  the  United 
States  —  to  mitigate  the  oscillations  of  industry  and  the  effects 
of  crises  —  could  be  rendered  only  if  it  refused  to  foster  the  con- 
ditions which  engender  crises.  And  here  it  would  be  sure  to 
meet  with  criticism  and  attack.  The  business  community 
likes  a  "boom."  Not  only  the  arrant  speculators,  but  the 
"solid  men"  also,  would  clamor  for  loans  to  help  trade,  to 
support  business,  to  finance  prosperity.  Unless  the  managers 
of  a  central  bank  could  say  no  firmly,  they  would  simply 
add  fuel  to  the  fire,  make  the  eventual  collapse  more  severe, 
the  inevitable  readjustment  more  painful.  Coolness,  inde- 
pendence, courage;  close  connection  with  business  affairs  and 
yet  aloofness  from  them,  —  this  is  a  policy  not  easy  to  follow, 

1  Compare  what  is  said  below,  Book  VII,  Chapter  62,  on  the  prospects  of 
public  management. 


PROBLEMS  OF  LEGISLATION  ON  BANKING        399 

yet  essential  for  a  great  bank  which  has  in  mind  not  the  largest 
pecuniary  gain,  but  the  permanent  public  good. 

The  same  problems  appear  under  the  Federal  Reserve  system 
established  in  1913.  That  system  is  partly  centralized,  partly 
decentralized;  the  national  banks  knit  together  by  the 
Reserve  Banks,  these  again  knit  together  by  the  supervising 
Federal  Board.  Its  success  must  depend  on  the  way  in  which 
it  is  administered  by  the  directors  of  the  Reserve  Banks  and 
the  members  of  the  Board.  It  has  great  possibilities  for  good ; 
though  is  also  not  without  its  possibilities  for  evil. 


CHAPTER  29 

CRISES 

§  1.  Two  great  sets  of  phenomena  will  be  considered  in 
this  chapter  and  in  that  which  follows, — industrial  crises  and 
financial  crises.  It  would  perhaps  be  more  accurate  to  say, 
not  that  two  sets  of  phenomena  will  be  considered,  but  that 
two  phases  of  one  and  the  same  phenomenon  will  be.  The 
industrial  and  financial  collapses  are  closely  connected.  Yet, 
if  only  for  convenience  in  exposition,  they  may  be  analyzed 
separately.  On  the  one  hand,  there  are  the  depressions  of 
industry  over  whole  countries,  often  international  in  their 
range,  taking  years  to  run  their  course,  and  connected  with 
far-reaching  social  problems.  On  the  other  hand,  there  are 
the  financial  panics,  which  affect  most  directly  the  banking 
and  mercantile  community,  run  their  course  in  a  few  weeks 
or  months,  and  are  associated  with  problems  of  money,  banking, 
and  credit.  The  present  chapter  will  deal  chiefly  with  the 
industrial  phases;  the  chapter  following,  chiefly  with  the 
financial. 

Both  sets  of  phenomena  show  a  certain  periodicity.  Financial 
panics  occur  with  curious  regularity,  and  each  is  likely  to  be 
followed  by  a  long-continued  stage  of  industrial  depression. 
Something  like  a  ten-year  period  has  long  been  observed.  In 
the  United  States,  for  example,  financial  crises  appeared  in  1818, 
1825,  1837,  1847,  1857.  Then  came  a  break  in  the  apparently 
regular  sequence ;  but  beginning  with  1873,  the  ten-year  cycle 
seemed  to  appear  again,  there  being  well-marked  crises  in  1873, 
1884,  1893,  1903.  A  double  pulsation  in  the  cycles  seems  also 
to  have  occurred.  The  crises  of  1818,  1837,  1857,  were  severe, 
those  of  the  intervening  periods  comparatively  mild.  Those 
of  1873  and  1893  were  again  severe ;  those  of  1884  and  1903, 

400 


CRISES  401 

mild.  Hence  some  writers  have  inferred  a  twenty-year  period 
for  great  crises,  with  others  of  less  severity  about  halfway 
between.  In  England  a  similar  periodicity  appears.  Indus- 
trial crises  have  come  in  the  main  at  the  same  time  as  in  the 
United  States,  though  not  always  with  the  same  intensity.  Thus 
the  crises  of  1818  and  1837  were  much  more  severe  in  the 
United  States,  those  of  1825  and  1847  more  severe  in  England. 
There  have  been  some  disturbances,  to  be  sure,  not  common 
to  both  countries.  For  example,  a  sharp  crisis  occurred  in 
England  in  1866,  to  which  there  was  no  obvious  counterpart  in 
the  United  States;  and  a  sharp  crisis  occurred  in  the  United 
States  in  1907,  to  which  there  was  no  obvious  counterpart  in 
England.  It  would  be  more  accurate,  probably,  to  say  that 
there  was  a  lower  intensity  of  disturbance  in  the  United  States 
in  1866  and  in  England  in  1907,  than  to  say  that  there  was  no 
counterpart;  for  every  crisis  has  in  modern  times  some  inter- 
national spread,  and  the  extent  of  its  effects  is  only  a  question 
of  degree.  Some  of  the  greatest  crises  have  been  sharply  felt 
the  world  over,  such  as  those  of  1857,  1873,  1893.  Others 
have  been  severe  in  one  country  only,  as  those  of  1866  for  Eng- 
land, and  of  1907  for  the  United  States,  or  1899  for  Germany. 

The  regularity  of  the  disturbances  led  to  Jevons's  striking  sun 
spot  theory,  which  holds  that  the  observed  recurrence  of  sun 
spots  every  ten  or  eleven  years  explains  the  recurrence  of  crises. 
Though  this  seems  at  first  blush  absurdly  far-fetched,  it  is  not 
beyond  the  bounds  of  possible  truth.  Jevons  maintained  that 
the  sun  spots  indicate  variations  in  the  heat  from  the  sun ;  this 
affects  vegetation  and  crops  on  the  earth,  which  in  turn  affects 
the  course  of  industry.  The  theory,  none  the  less,  has  never 
had  acceptance.  A  similar  explanation  has  been  sought  in 
fluctuations  in  precipitation  over  decades,  which  again  operate 
by  their  influence  on  crops. 

All  explanations  of  this  sort  rest  on  an  exaggeration  of  the 
regularity  of  the  fluctuations.  For  some  periods  the  ten-year 
cycles  have  indeed  been  curiously  regular,  as  from  1818  to  1857, 
and  again  (in  the  United  States  at  least)  from  1873  to  1903. 


402        MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

But  the  regularity  has  not  been  that  of  a  well-defined  natural 
phenomenon.  After  the  crisis  of  1837  in  the  United  States, 
there  was  another  in  1839.  There  was  a  break  in  the  apparent 
ten-year  sequence,  as  we  have  noted,  from  1866  to  1873 ;  an- 
other from  1903  to  1907.  There  have  been  disturbances  in 
intermediate  years,  not  so  often  noted,  but  not  less  well-marked. 
So  in  England  in  1890,  when  something  very  near  to  a  crisis 
developed  in  the  United  States  also;  again  in  Germany  in 
1899.  France  has  been  singularly  little  affected  by  some  of 
the  world-wide  crises.  The  crash  of  1873,  for  example, 
brought  hardly  a  ripple  in  that  country;  whereas  she  has 
had  some  marked  revulsions  of  her  own,  as  in  the  failure  of 
the  Comptoir  d'Escompte  in  1889. 

None  the  less,  unmistakable  repetition  and  some  periodicity 
we  do  find.  Periods  of  activity  recur,  followed  by  periods  of  de- 
pression, with  an  acute  breakdown  to  mark  the  revulsion  from 
one  extreme  to  the  other.  The  symptoms  throughout  are  fa- 
miliar. During  the  stage  of  activity,  new  enterprises  are  freely 
launched,  old  ones  find  a  ready  market  for  their  products,  busi- 
ness men  are  confident  and  even  optimistic,  labor  finds  regular 
and  well-paid  employment.  Credit  is  easily  expanded,  prices 
rise,  rates  of  interest  and  discount  tend  gradually  to  go  up. 
Toward  the  latter  part  of  such  a  stage,  there  is  apt  to  be  a  period 
of  halt  and  uncertainty,  —  something  like  a  premonitory  chill. 
Then  new  enterprises  find  unexpected  obstacles,  while  those  half- 
launched  must  bid  high  in  order  to  get  the  funds  they  wish. 
Rates  of  discount  rise,  and  scarcity  of  money  is  complained  of. 
Suddenly  there  comes  an  overturn,  usually  precipitated  by  the 
failure  of  some  well-known  banking  establishment.  Thus  in 
1857  came  the  collapse  in  the  United  States  of  the  Ohio  Life 
Insurance  and  Trust  Company;  in  1866  in  England,  that  of 
Overend,  Gurney  and  Company,  a  great  firm  of  bankers  and 
brokers;  in  1873,  that  of  Jay  Cooke  and  Company,  a  famous 
American  banking  house.  In  1884  three  large  national  banks 
failed  in  New  York ;  in  1907  the  Knickerbocker  Trust  Company 
failed  in  the  same  city,  with  other  banking  institutions  dragging 


CRISES  403 

in  its  train.  Then  follows  the  acute  stage,  —  the  monetary 
crisis.  Banks  are  confronted  by  sudden  great  demands;  they 
are  pressed  both  to  enlarge  their  loans  and  to  pay  out  their  cash  ; 
business  houses  fail;  in  the  worst  cases,  as  in  1857  and  1873, 
even  in  1907,  a  complete  paralysis  of  industry  sets  in.  With  the 
more  or  less  rapid  subsidence  of  this  acute  phase,  the  period  of 
industrial  depression  begins.  No  new  enterprises  are  launched, 
old  ones  contract  their  operations,  employment  is  comparatively 
scant  and  uncertain.  Cash  accumulates  in  the  banks,  reserves 
are  high,  rates  of  interest  and  discount  low,  prices  tend  to  fall. 
Then,  after  a  few  years,  bottom  is  touched,  revival  sets  in 
slowly,  and  the  old  round  is  repeated. 

§  2.  The  causes  of  the  larger  oscillations,  —  the  industrial 
phenomena,  —  are  to  be  found  partly  in  the  division  of  labor  and 
the  time-using  or  capitalistic  method  of  production ;  and  partly 
hi  some  elemental  traits  of  human  nature.  They  are  partly 
economic,  partly  psychological. 

We  have  already  noted  the  successive  division  of  labor  :  the 
marshaling  of  different  stages  in  the  processes  of  production. 
Thence  ensues  an  interval,  often  long,  between  the  first  stages  of 
production  and  the  final  emergence  of  the  consumable  com- 
modity. Thence  comes  the  possibility  of  mistake  and  malad- 
justment, and  also  the  possibility  that  the  maladjustment  will 
not  be  promptly  ascertained.  Here  is  one  great  cause  of  the 
industrial  crisis,  —  ill-adjusted  production. 

This  cause  acts  most  strongly  when  rapid  changes  are  taking 
place  in  the  arts.  Crises  have  appeared  on  the  largest  scale 
and  with  the  widest  effects  during  the  period  since  the  Industrial 
Revolution,  and  in  the  countries  whose  progress  has  been  most 
rapid.  When  there  are  heavy  investments  of  capital  in  new  en- 
terprises, then  the  chances  of  error  are  greatest,  and  at  the  same 
time  a  course  of  error  can  be  persisted  in  for  the  longest  time 
without  retribution.  The  railways,  so  far-reaching  in  all  their 
industrial  effects,  have  been  of  the  first  consequence  here  also. 
Many  of  the  crises  of  the  nineteenth  century  were  closely  as- 
sociated with  excessive  or  unprofitable  railway  building.  Such 


404        MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

were  the  crises  of  1837  in  the  United  States,  of  1847  in  England, 
and  again  of  1857  and  1873  and  1884  in  the  United  States.  A 
railway  takes  a  long  time  to  build,  and  calls  for  very  large  in- 
vestment. While  it  is  being  built,  and  for  some  time  after  it  is 
completed,  there  is  uncertainty  as  to  how  far  it  will  prove  profit- 
able, —  and  profit  is  usually  the  test  of  serviceability.  The 
railway  opens  up  new  territory,  or  rearranges  the  geographical 
division  of  labor  in  old  territory.  Not  until  it  has  been  in 
operation  for  some  years  can  it  be  definitively  known  whether 
the  final  increase  in  enjoyable  goods,  or  human  satisfactions,  has 
been  such  as  to  justify  the  huge  investment.  Railways  have 
sometimes  been  built  into  regions  where  no  advantageous  de- 
velopment at  all  proved  to  follow.  More  often  they  have  been 
built  faster  than  the  rest  of  the  industrial  structure  could  be 
adjusted  to  their  transforming  effects;  hence  there  has  been  a 
long  interval  during  which  they  were  not  yet  profitable. 

The  same  possibility  of  miscalculation  and  maladjustment  ap- 
pears in  all  making  of  plant.  It  shows  itself  most  in  those  in- 
dustries which  supply  the  materials  used  in  fixed  capital  and 
machinery,  —  those  which  stand  at  the  very  beginning  of  the 
processes  of  production  and  farthest  removed  from  final  fruition 
in  enjoyable  goods.  Such  are  the  industries  supplying  iron, 
timber,  stone,  and  the  like.  Iron  is  in  modern  times  the  most 
important  of  these  materials  and  feels  more  than  any  other  the 
fluctuations  of  industrial  activity.  Iron  and  steel  are  in  de- 
mand chiefly  for  investment.  The  millions  of  tons  which  are 
turned  out  annually  mean  new  instruments  of  production,  new 
railways,  new  structures,  new  appliances.  These  added  instru- 
ments bring  eventually  more  consumable  goods ;  but  whether 
of  the  kind  which  will  be  in  demand,  or  so  adjusted  to  the 
demand  as  to  be  sold  at  a  profit,  is  very  difficult  to  predict. 

§  3.  Here  the  psychological  factor  comes  into  play.  A  per- 
vading spirit  of  optimism  fills  most  business  men  in  times  of 
activity,  as  a  spirit  of  pessimism  does  in  times  of  depression. 
A  few  very  sagacious  and  sober  persons  may  indeed  remain  un- 
affected. These  hold  off  when  others  press  on,  and  venture  freely 


CRISES  405 

when  others  hesitate.  But  they  are  as  rare  as  the  persons  who 
remain  rational  in  a  mob  or  quiet  in  a  cheering  crowd.  Most 
business  men  respond  to  the  influences  that  surround  them. 
They  enter  on  new  enterprises  or  enlarge  old  ones  when  all 
the  world  about  them  is  doing  likewise. 

This  contagion  is  not  merely  contagion ;  it  rests  on  a  real 
interdependence.  Business  men  are  chiefly  buying  and  selling 
with  each  other.  Only  the  retail  tradesmen,  and  such  industries 
(essentially  retail  in  character)  as  street  railways,  are  dealing 
with  the  final  consuming  public.  The  maker  of  iron  and  steel 
sells  to  the  maker  of  machinery,  he  to  the  manufacturer,  he  to 
the  wholesale  agent  or  jobber,  he  to  the  retailer.  Every  one  of 
these,  unless  possessed  of  almost  unlimited  capital  or  credit  on 
his  own  account,  necessarily  depends  on  what  others  will  buy  of 
him.  Whatever  be  his  own  opinion  of  the  source  or  extent  of 
ultimate  demand,  the  direct  influence  on  him  conies  from  those 
who  stand  next  in  the  long  chain  of  apparently  separate,  yet 
essentially  interdependent,  operations. 

A  curious  part,  and  one  too  much  neglected  in  discussion  about 
the  course  of  crises,  is  played  by  the  distributing  middlemen,  — 
the  wholesalers  and  jobbers  and  retailers.  These  constitute  the 
immediate  purchasing  public  for  the  "producers."  When  they 
buy  freely,  business  is  brisk ;  when  they  hold  off,  business  is  dull. 
They  are  not  only  subject  to  the  psychological  contagion;  they 
are  also  moved  by  very  simple  calculations  of  profit  and  loss. 
Their  operations  are  almost  exclusively  in  the  simple  purchase 
and  sale  of  goods,  and  their  success  depends  almost  solely  on 
prices.  They  buy  freely  when  they  think  that  prices  will  rise, 
and  cut  down  purchases  when  they  think  that  prices  will  fall. 
The  very  fact  that  they  so  think,  and  accordingly  act,  accelerates 
the  rise  of  prices  in  the  one  case,  and  accelerates  the  fall  in  the 
other.  During  an  up-swing  period,  they  add  to  their  stocks, 
thinking  to  sell  them  at  an  advance,  or  at  least  to  protect 
themselves  against  a  later  rise  in  the  prices  of  what  they  buy. 
Then  comes  the  shock,  —  a  bad  failure,  a  financial  panic. 
They  jump  to  the  conclusion  that  "things  are  going  down," 


406        MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

countermand  old  orders  as  far  as  possible,  give  no  new  ones 
live  from  hand  to  mouth  in  their  purchases  and  sales,  and  wait 
until  they  think  that  prices  have  touched  bottom.  Sooner  or 
later  a  good  crop,  the  unexpected  profitableness  of  some  new 
venture,  a  turn  in  foreign  trade,  —  some  such  event  gives  the 
start  to  a  new  upward  movement.  The  middlemen  reach  the 
conclusion  that  it  is  time  to  buy  again,  and  to  take  advantage  of 
low  prices.  Business  becomes  more  active,  optimism  returns. 
Prices  go  up,  and  go  up  the  more  certainly  and  quickly  because 
all  the  dealers  now  think  they  will  go  up,  and  buy  in  consequence. 
There  is  thus  an  accumulation  of  extra  stocks  in  their  hands  in 
times  of  rising  prices,  and  a  depletion  in  times  of  low  prices; 
some  really  increased  flow  to  consumers  at  the  one  stage,  some 
really  lessened  flow  at  the  other ;  but  also  an  alternate  excess 
and  deficiency  of  the  supplies  held  in  the  middlemen's  reser- 
voirs. 

§  4.  During  a  stage  of  depression,  the  industrial  machine 
seems  to  be  half-stalled.  The  different  parts  do  not  act  together. 
The  dealers  and  middlemen  perform  their  functions  haltingly. 
They  do  not  buy  the  accustomed  or  normal  supplies,  because 
they  are  uncertain  of  what  the  future  will  bring.  The  very  fact 
that  they  curtail  purchases,  causes  the  manufacturing  em- 
ployers to  cut  down  production.  Workmen  are  thrown  out  of 
employment,  and  in  turn  do  not  buy  of  the  retailers.  During 
the  brief  but  acute  phase  of  the  financial  crisis,  there  is  some- 
times a  universal  collapse.  Nobody  buys,  nobody  can  sell ;  no- 
body employs,  nobody  can  find  work.  This  phase  rarely  lasts 
more  than  a  week  or  two ;  but  it  is  likely  to  be  followed  by  a  pro- 
longed period  of  halting  purchases,  lessened  production,  uncer- 
tain employment.  The  intricate  machinery  of  production  and 
exchange  is  first  thrown  violently  out  of  gear  by  the  financial 
collapse ;  and  though  this  may  be  short-lived,  and  the  mech- 
anism may  be  got  at  work  again,  it  shows  the  effects  of  the 
shock  for  a  long  time,  and  does  its  work  ineffectively. 

The  period  of  hesitancy  and  "poor  business"  lasts  a  longer  or 
a  shorter  time,  according  as  there  has  been  during  the  preceding 


CRISES  407 

active  period  more  or  less  of  real  maladjustment  in  the  indus- 
trial arrangements.  If,  for  example,  there  have  been  really  too 
many  railways  built  for  present  needs,  too  many  electric  en- 
terprises launched,  too  much  iron  and  steel  made,  too  many 
factories  put  up,  —  then  there  must  be  a  wait  until  some  of  these 
appliances  (the  older  and  poorer)  have  been  abandoned,  or  until 
the  growth  of  population  and  of  other  industries  has  restored 
the  due  equilibrium  in  the  division  of  labor.  Thus  in  the  years 
before  the  great  crisis  of  1873  there  had  been  very  rapid  railway 
building  in  the  United  States,  while  the  fundamental  industry 
of  the  land  —  agriculture  —  had  been  neglected.  During  the 
long  years  of  depression  that  followed,  railway  construction 
stood  still ;  but  a  great  increase  took  place  gradually  in  the  popu- 
lation and  resources  of  the  agricultural  states  of  the  Middle  West. 
Then  in  1879-1880  there  came  a  sudden  turn,  the  first  impulse 
being  given  by  a  change  in  foreign  trade  ;  large  crops  had 
been  reaped  and  good  prices  were  got  for  them.  All  was  ready 
for  a  revival;  the  industrial  readjustment  had  really  been  car- 
ried out ;  the  business  community  (in  this  case  suddenly)  woke 
up  to  the  fact,  and  a  new  period  set  in,  with  all  its  concomitants 
of  general  hopefulness,  free  purchases,  active  speculation,  new 
enterprises  of  all  sorts,  and  the  consequent  incubation  of  a  new 
crisis  and  a  new  era  of  depression. 

Since  the  psychological  factor  is  of  such  central  importance, 
the  extent  and  duration  of  the  so-called  good  and  poor  times,  and 
the  particular  occasion  of  the  turn  one  way  or  the  other,  seem 
to  rest  on  accident,  —  that  is,  on  irregular  and  unpredictable 
causes.  An  unexpected  great  failure  may  precipitate  a  crisis. 
Unexpected  good  crops  sold  at  high  prices  (a  combination  which 
the  United  States  have  been  fortunate  in  enjoying  sundry  times) 
may,  on  the  other  hand,  postpone  one  that  is  fairly  due.  This 
last  seems  to  have  been  the  case  in  1890-1891.  Then  all  the 
materials  for  a  revulsion  were  present ;  but  a  turn  in  agricultural 
prosperity  put  the  day  of  reckoning  off  for  a  year  or  two,  and  the 
crisis  finally  came,  with  special  severity,  in  1893.  This  crisis 
and  the  ensuing  period  of  depression  were  intensified  and  compli- 


408     MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

cated  by  the  political  struggle  in  regard  to  the  silver  question, — 
should  the  money  of  the  country  rest  on  a  gold  or  a  silver  basis  ? 
—  a  question  which  necessarily  made  many  business  operations 
uncertain,  and  which,  in  its  psychological  effects,  created  even 
more  uncertainty  and  hesitancy  than  the  monetary  question  per 
se  made  inevitable.  The  revival  which  set  in  after  1896  was  pro- 
moted, again,  by  all  sorts  of  causes  :  the  Republican  victory  at 
the  polls,  which  promised  the  maintenance  of  a  secure  gold  stand- 
ard, and  another  favorable  turn  in  foreign  trade.  In  view  of 
the  frequent  appearance  of  irregular  causes  of  this  sort,  the 
degree  of  regularity  which  still  persists  in  the  recurrence  of 
crises  is  surprising. 

It  is  probable  that  depression  is, less  prolonged,  and  revival 
more  easy,  when  the  underlying  conditions  are  favorable  to  ris- 
ing prices ;  when,  for  example,  the  supply  of  specie  is  increasing 
markedly.  It  is  possible,  on  the  other  hand,  that  these  very 
conditions  increase  the  speculative  and  uncalculating  activity  of 
the  period  of  incubation,  and  make  the  collapse  more  disastrous 
when  it  comes.  Thus  the  crisis  of  1857came  after  the  Californian 
and  Australian  gold  discoveries  had  given  for  years  the  basis  of 
rising  prices.  It  was  very  severe,  and  yet  was  short-lived  in  its 
course  ;  within  a  year  or  two  its  effects  seem  to  have  worn  away. 
The  crisis  of  1873,  on  the  other  hand,  was  followed  by  a  period 
of  general  falling  prices,  especially  in  the  United  States,  where 
a  decline  from  a  regime  of  inflated  paper  prices  was  gradually 
and  painfully  taking  its  course ;  and  the  period  of  depression 
after  1873  was  unusually  long. 

§  5.  Still  a  further  factor  is  to  be  noted  in  connection  with 
industrial  crises,  the  increase  of  capital  and  its  relation  to  sav- 
ings and  to  banking  operations. 

New  enterprises  mean  on  the  one  hand  the  creation  of  real 
capital,  and  on  the  other  hand  the  accumulation  of  fresh  savings, 
—  the  double  process  by  which,  under  the  regime  of  private 
property,  the  capital  of  the  community  is  added  to.  The  em- 
ploying capitalists  borrow  from  the  investors,  or  in  other  ways  en- 
list their  savings.  Though  the  bankers  and  active  business  men 


CRISES  409 

invest  some  accumulations  of  their  own,  they  secure  funds  very 
largely  from  the  inactive  investors.  In  any  case,  whether  using 
their  own  means  or  those  of  others,  they  cannot  invest  more 
than  the  available  savings  of  the  community  make  possible. 
But  this  limitation  is  a  long-period  one.  It  does  not  operate 
directly,  but  through  a  series  of  middlemen. 

The  development  of  corporations  and  the  consequent  growth 
of  opportunities  for  investment  by  inactive  investors  have 
greatly  enlarged  and  complicated  all  this  mechanism.  New 
enterprises  nowadays  are  usually  launched  in  corporate  form, 
and  the  money  means  for  carrying  them  on  are  procured  by 
putting  stocks  and  bonds  on  the  market.  The  stocks  and 
bonds  are  first  sold  mainly  to  banking  and  investment  houses, 
and  by  these  are  retailed  to  investors.  The  banking  and  in- 
vestment house,  while  it  does  not  guarantee  the  solidity  of  the 
securities  which  it  puts  on  the  market,  yet  feels  a  responsibility 
for  them.  Its  prestige  and  permanent  prosperity  are  involved 
in  promoting  only  successful  ventures.  The  most  important 
and  useful  function  of  such  firms  and  institutions  is  the  exer- 
cise of  judgment  regarding  new  enterprises ;  and  here,  too,  is 
the  main  source  of  their  profit.  But  they  have  no  way,  beyond 
shrewd  guesswork,  of  estimating  the  total  amount  of  securities 
which  the  investing  public  can  buy.  In  times  of  buoyancy 
and  hope,  the  various  investment  firms  go  ahead  without  hesi- 
tation, and  take  the  securities  of  all  promising  enterprises. 
They  advance  their  own  means,  and  borrow  more  on  short 
time  from  the  strictly  commercial  banks.  The  whole  banking 
and  brokerage  and  stock-jobbing  fraternity  is  borrowing  and 
lending,  and  buying  and  selling  securities.  Many  of  the 
smaller  fry  and  the  "outside"  speculators  exercise  no  inde- 
pendent judgment  at  all,  but  simply  buy  or  sell  with  the  crowd, 
swallow  all  sorts  of  exaggerated  statements  or  rumors,  think 
only  of  the  prices  of  securities  from  day  to  day,  and,  in  the 
contagion  of  the  moment,  are  singularly  inattentive  to  the 
fundamental  forces  on  which  their  doings  are  based.  The 
psychological  factor  plays  a  large  part. 


410  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

When  this  has  gone  on  awhile,  it  begins  to  appear  that 
more  has  been  undertaken  than  the  accruing  savings  of  the 
community  make  possible.  The  mass  of  securities  offered  to 
investors  is  greater  than  these  have  the  means  to  buy.  The 
rate  of  interest  on  long  investments  rises,  as  does  the  rate  of 
discount  on  bank  loans.  New  enterprises  now  find  it  difficult 
to  get  support;  while  those  already  launched  find  it  harder 
and  harder  to  procure  the  additional  funds  needed  for  com- 
pleting their  outfit.  The  commercial  banks  demur  at  renewing 
loans  to  the  corporations  and  individuals  who  have  borrowed 
of  them  under  pledge  of  new  or  old  securities  as  collateral. 
Simultaneously  there  is  likely  to  be  a  check  in  mercantile  ex- 
pansion, a  halt  in  the  general  upward  movement.  On  all  sides 
it  appears  that  the  means  for  additional  investment  operations 
have  been  overtaxed. 

The  beginning  of  a  revulsion  usually  comes,  as  has  been 
said,  with  a  financial  failure.  Some  banking  house  which  has 
exceeded  its  own  resources  and  that  of  its  clientele,  or  which 
has  exercised  bad  judgment  upon  a  new  venture,  goes  to  the 
wall,  and  precipitates  a  general  collapse.  Thus  the  firm  of 
Jay  Cooke  and  Company,  whose  failure  marked  the  beginning 
of  the  crisis  of  1873,  had  promoted  the  building  of  the  Northern 
Pacific  Railway,  —  a  great  undertaking,  and  one  eventually  suc- 
cessful, but  then  far  ahead  of  the  population  and  industries 
of  the  region  traversed.  With  the  general  ensuing  collapse,  it 
became  clear  that  there  had  been  many  such  premature  enter- 
prises, as  well  as  not  a  few  ill-judged  ones,  and  that  more  of 
new  capital  had  been  planned  than  the  available  savings  made 
possible.  This  was  indeed  the  case  the  world  over  before  the 
crisis  of  1873.  It  seems  to  have  been  again  the  case  the  world 
over  in  the  opening  years  of  the  present  century,  leading  to 
the  breakdown  of  1907. 

In  sum,  the  causes  of  industrial  depression  seem  to  be  re- 
ducible to  various  kinds  of  maladjustment,  all  connected  with 
the  intricate  division  of  labor  and  the  long  stretch  from  pro- 
duction to  consumption.  There  is  likely  to  be  maladjustment 


CRISES  411 

in  the  planning  of  some  particular  kind  of  capital,  —  railways, 
or  electric  enterprises,  or  textile  mills.  There  is  likely  to  be 
maladjustment  in  a  greater  addition  to  the  total  of  the  com- 
munity's capital  than  is  justified  by  the  total  of  its  avail- 
able savings.  There  is  excess  or  deficiency  in  the  stocks  of 
dealers  and  middlemen.  There  is  accentuation  of  the  whole 
series  of  misfits  because  of  the  psychological  factor.  The 
greater  the  maladjustment  of  all  sorts,  the  more  prolonged  and 
painful  will  be  the  ensuing  process  of  readjustment  and  recovery. 


CHAPTER  30 
FINANCIAL  PANICS 

§  1.  The  financial  panic  which  commonly  appears  as  the 
acute  stage  of  a  crisis  affects  both  the  general  business  and 
mercantile  firms,  and  the  banks  and  financial  institutions. 
Though  these  two  groups  are  affected  together,  their  fortunes 
being  always  interlaced,  it  will  conduce  to  clearness  if  they 
are  considered,  so  far  as  possible,  separately.  We  will  begin 
with  the  general  business  community. 

All  business  men  conduct  their  affairs  on  the  basis  of  giving 
and  taking  credit.  Each  individual  is  both  creditor  and 
debtor,  has  his  bills  payable  and  his  bills  receivable.  In  the 
ordinary  course  of  things,  these  obligations  are  met  punctiliously. 
Failure  to  meet  them  means  that  the  delinquent  loses  his 
standing  in  the  business  world;  he  is  no  longer  in  the  game. 
It  is  on  this  severe  ground  of  expediency  that  the  discount 
of  mercantile  paper  is  so  secure  a  banking  investment.  And 
the  commercial  banks,  it  need  hardly  be  said  again,  find  their 
main  reason  for  existence  in  taking  over  the  loans  and  discount- 
ing the  paper  of  active  business  men. 

Anything  which  unsettles  the  expectation  that  mercantile 
debts  will  be  promptly  met,  may  cause  a  panic  among  business 
men.  Each  knows  that  his  paper  is  coming  due,  and  that  to 
enable  him  to  meet  it  he  must  receive  payment  of  what  is 
coming  due  to  himself.  If  he  fails  to  pay  his  own  obligations, 
he  gets  poor  comfort  from  the  fact  that  his  own  failure  is 
due  to  the  failure  of  his  debtors  to  pay ;  his  standing  is  broken 
none  the  less.  Now  all  obligations  are  likely  to  be  greater, 
and  more  dependent  each  on  the  other,  during  an  upward  in- 
dustrial movement.  Where  there  has  been  some  really  serious 
maladjustment,  some  failures  are  inevitable.  But  then  it 

412 


FINANCIAL  PANICS  413 

becomes  also  possible  that  one  failure  will  entail  another,  and 
this  still  another,  until  business  firms  topple  over  in  succession 
like  a  row  of  bricks.  Of  this  sort  of  collapse  a  dramatic  ex- 
ample occurred  in  the  great  crisis  of  1857,  when,  both  in  England 
and  the  United  States,  an  extraordinary  number  of  firms  col- 
lapsed. 

When  the  storm  is  brewing,  the  one  thing  needed  in  the 
business  community  is  assurance  against  indiscriminate  ruin. 
This  can  be  given  by  the  banks,  if  they  are  themselves  in  a 
position  to  render  aid.  What  merchants  and  manufacturers 
want  at  such  times  is  "accommodation."  They  do  not  want 
cash.  As  will  presently  appear,  when  we  take  up  the  banking 
phase  of  the  crisis,  there  may  be  at  the  same  time  a  run  on  the 
banks^  for  cash,  especially  in  the  deposit-using  countries.  But 
while  some  business  men  may  join  in  the  run,  it  rarely  touches 
the  mercantile  community  at  large.  What  is  needed  for  its 
peace  of  mind  is  primarily  the  assurance  that  support  will  be 
afforded  against  possible  temporary  embarrassment.  Loans  are 
wanted,  not  cash;  or  rather,  assurance  that  loans  can  be  had 
if  needed.  Business  men  want  to  be  "taken  care  of."  In 
deposit-using  countries,  they  want  the  banks  to  make  them 
advances  —  to  credit  them  with  deposits  —  which  can  be  used 
in  meeting  their  accruing  obligations,  even  though  the  debts  due 
to  themselves  fail  to  be  met  promptly. 

§  2.  The  banks  (to  proceed  to  the  other  phase  of  the  situa- 
tion) are  thus  confronted  with  an  intensified  demand  for  loans. 
At  the  same  time  they  are  likely  to  be  confronted  with  a  de- 
mand for  additional  cash.  The  two  are  in  conflict  with  each 
other;  for  a  drain  of  cash  means  a  lessening  of  the  resources 
on  which  depends  an  increase  of  loans.  None  the  less,  in  times 
of  panic,  the  only  sound  policy  for  banks,  in  their  own  interest 
as  well  as  in  that  of  the  community,  is  to  lend  freely.  Toward 
carrying  out  that  policy,  a  great  central  institution  can  give 
unmistakable  aid.  The  central  public  bank  has  a  conscious 
duty  toward  the  public,  and,  rightly  conducted,  is  prepared 
for  the  performance  of  its  duty  in  times  of  stress.  By  provid- 


414       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

ing  cash  from  its  own  ample  holdings ;  by  making  loans  itself ; 
not  least  by  bolstering  up  the  banks  at  large  so  that  each 
of  them  is  encouraged  to  take  care  of  its  own  customers,  — 
the  great  central  bank  can  certainly  mitigate  a  panic,  and 
can  probably  prevent  the  stage  of  general  collapse  from  being 
reached.  The  Bank  of  England  has  learned  by  long  and  hard 
experience,  but  has  thoroughly  learned,  that  free  offering  of 
accommodation  of  all  sorts  is  the  way  to  meet  a  panic.  The 
rate  of  discount  is  indeed  advanced  by  the  Bank,  perhaps 
sharply ;  and  it  is  advanced  by  other  banking  institutions  also. 
But  all  solvent  business  firms  have  the  assurance  that  loans 
can  be  had  if  wanted.  The  same  assurance  is  given  by  the 
great  public  banks  of  the  Continent,  which,  different  though 
they  are  in  their  constitution  and  in  their  methods  from  the 
Bank  of  England,  have  learned  with  comparative  ease,  from 
the  trying  history  of  the  great  English  institution,  that  bold 
generosity  is  the  proper  policy  in  a  panic. 

Such  is  the  policy  which  the  banks  of  the  United  States  should 
adopt,  —  boldness  and  liberality.  This  policy,  it  is  fair  to  say, 
they  do  largely  follow.  The  strong  and  carefully  managed 
banks  of  the  larger  cities  have  faced  crises  with  courage,  and 
have  permitted  none  of  their  solvent  customers  to  go  by  de- 
fault. But  the  maintenance  of  a  bold  stand  is  very  difficult 
for  scattered  and  independent  banks,  without  any  acknowledged 
and  responsible  head.  And  there  are  peculiar  difficulties  from 
the  unusual  development  of  deposit  banking  in  this  country. 
The  banks  themselves  are  likely  to  be  in  peril  during  a  panic, 
and  thus  not  in  a  position  to  give  vigorous  support  to  others. 

The  policy  of  bold  lending  necessarily  involves  risk.  Lend 
freely  to  solvent  persons,  —  but  who  is  solvent  ?  The  emer- 
gency usually  comes  after  a  period  of  active  expansion,  when 
many  new  ventures  have  been  started  and  when  prices  have 
been  raised  by  credit  expansion.  How  will  half-finished  opera- 
tions or  newly  completed  plants  turn  out?  How  far  will 
mercantile  engagements  stand  the  strain  of  lower  prices? 
These  must  be  matters  of  uncertainty.  At  one  extreme  there 


FINANCIAL  PANICS  415 

will  be  many  business  houses  of  unquestionable  solidity,  subject 
only  to  possible  temporary  embarrassment.  These  should 
clearly  be  supported.  At  the  other  extreme  will  be  some  of 
unquestionable  insolvency,  —  the  agents  or  the  victims  of  ill- 
judged  and  unsuccessful  investments.  These  must  succumb 
to  the  inevitable.  Between  will  stand  not  a  few  firms  with 
large  commitments,  large  liabilities,  more  or  less  uncertain 
assets.  How  far  to  go  in  supporting  these,  calls  for  the  exer- 
cise of  the  banker's  highest  faculties  of  judgment.  Here,  again, 
the  great  public  bank  can  take  some  risks  which  the  private 
bank,  however  large  and  however  strong,  must  regard  with 
hesitation.  Thus  in  1890  the  Bank  of  England  took  the  lead 
in  committing  itself  heavily  in  guaranteeing  the  liabilities  of 
the  Barings  when  that  famous  banking  firm  was  in  danger. 
In  1889  the  Bank  of  France  did  substantially  the  same  thing 
for  a  large  Paris  banking  institution,  the  Comptoir  d'Escompte, 
whose  impending  failure  would  have  shaken  the  French  busi- 
ness community ;  and  in  1900  the  Reichsbank  of  Germany  took 
the  risk  of  bolstering  up  the  threatened  Dresdner  Bank.  These, 
as  it  happens,  are  all  cases  in  which  the  public  banks  extended 
aid  to  other  banking  institutions ;  but  the  latter  were  in  diffi- 
culties because  of  their  advances  in  support  of  miscellaneous 
business  enterprises.  The  same  sort  of  aid  to  seriously  en- 
dangered banks  and  firms  has  been  given  by  the  associated 
banks  of  the  American  cities;  but  with  reluctance  and  some- 
times with  a  possibility  of  eventual  loss,  and  only  under  the 
persuasion  that  even  greater  loss  would  come  from  the  precipi- 
tation of  a  general  panic.  The  right  line  is  not  easily  drawn 
in  such  circumstances  between  deserved  retribution  for  indi- 
vidual offenders  and  undeserved  harm  to  the  business  com- 
munity at  large. 

In  Continental  countries,  where  deposit  banking  is  less 
developed,  some  of  the  phenomena  of  crises  are  different  from 
those  in  England  and  the  United  States.  But  to  the  degree 
to  which  their  industry  is  active  and  progressive,  they  are 
subject  to  mercantile  crises  as  well  as  to  the  larger  oscillations 


416   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

of  activity  and  depression.  There  is  the  same  interlacing  of 
business  men's  obligations,  the  same  probability  of  general 
expansion  of  business  and  general  enlargement  of  obligations, 
the  same  possibility  of  panic  and  collapse. 

§  3.  There  are  some  phases  of  the  general  disturbance  which 
specially  affect  the  banks  of  deposit-using  countries,  and  most 
of  all  those  of  the  United  States. 

Deposit  banking  implies  that  the  banks  have  a  great  volume 
of  demand  liabilities,  and  a  comparatively  small  amount  of 
cash  with  which  to  meet  them.  If  there  is  a  general  and 
sustained  run  on  alt  the  banks,  the  cash  almost  inevitably 
proves  insufficient.  There  is  then  nothing  left  except  a  general 
suspension  of  cash  payments.  To  prevent  such  a  general  run, 
to  maintain  the  confidence  of  depositors,  to  keep  in  working 
order  this  intricate  part  of  the  machinery  of  exchange,  —  this 
is  the  object  which  legislation  and  the  policy  of  banks  strive  for. 

When  any  one  bank  is  beset  by  a  run  —  caused  perhaps  by 
some  unfounded  rumor,  some  unreasoning  fright  among  its 
depositors  —  it  appeals  for  aid  to  the  other  banks.  These 
have  the  strongest  motive  for  granting  aid,  by  supplying  cash 
from  their  own  holdings ;  since  fright  is  contagious,  and  the 
failure  of  any  one  bank  is  likely  to  precipitate  a  general  run. 
But  the  condition  on  which  aid  is  granted  usually  is,  and  always 
ought  to  be,  that  the  bank  in  straits  be  solvent ;  that  its  loans 
and  other  assets  prove  on  examination  to  be  sound,  and  suffi- 
cient in  the  ordinary  course  of  events  to  meet  its  liabilities. 
The  possibility  of  a  run,  and  the  necessity  in  that  case  of  ex- 
posing its  whole  situation  to  critical  professional  eyes,  are  the 
strongest  forces  for  preventing  reckless  and  dishonest  banking. 
A  bank  which  is  once  fairly  going,  even  though  it  be  really  in- 
solvent, can  keep  going  for  a  long  time.  It  can  carry  on  its 
books,  as  if  good,  loans  or  securities  which  are  bad.  So  long  as 
depositors  continue  their  daily  round  of  deposits,  loans,  checks, 
there  is  little  to  reveal  the  true  situation.  But  once  there  is 
a  run,  the  bank  must  show  its  hand.  Where  there  is  an  organ- 
ized clearing  house,  a  committee  representing  this  institution 


FINANCIAL  PANICS  417 

(that  is,  the  combined  banks  of  the  place)  examines  the  threat- 
ened member,  and  learns  whether  aid  is  deserved.  If  it  is, 
the  reserves  of  all  the  banks  are  massed  at  the  point  of  danger. 
Every  depositor  in  the  imperiled  institution  is  told  he  can 
have  his  cash  if  he  wishes  it;  and  at  the  same  time  public 
assurance  is  given  by  the  clearing  house  committee  that  the 
bank  is  solvent.  And  if  it  is  not  solvent,  and  must  be  wound 
up  with  possible  loss  to  depositors,  the  combined  banks  face 
the  situation  boldly,  "take  care"  of  the  embarrassed  depositors, 
and  endeavor  to  quiet  general  apprehension.  By  such  means 
an  incipient  panic  may  be  averted.1 

But  when  there  is  a  general  panic  and  a  general  run  —  when, 
moreover,  some  banks  are  really  insolvent,  and  others  are  in  an 
uncertain  condition  —  the  situation  is  more  difficult  to  handle. 
Here  again  it  is  unquestionably  a  vast  advantage  if  there  be 
some  one  great  strong  institution  with  ample  cash  holdings  and 
unshakable  prestige.  For  the  banking  institutions  of  the  United 
Kingdom,  the  Bank  of  England  is  in  such  times  the  citadel  of 
refuge.  It  can  undertake  to  supply  cash  when  needed,  and  to 
guarantee  solvency  if  there  be  real  solvency.  Thus  in  the  strik- 
ing case  already  referred  to,  in  1890,  when  the  threatened  sus- 
pension of  the  Barings  might  have  caused  a  calamitous  panic,  the 
Bank  not  only  took  the  lead  in  guaranteeing  that  firm's  liabil- 
ities, but  prepared  to  strengthen  the  whole  credit  structure 
of  the  country.  It  secured  an  extra  store  of  cash  from  the  Bank 
of  France,  and  it  made  ready  for  a  possible  suspension  of  the 
Bank  Act  of  1844,  —  the  maneuver  already  described  2  for 
getting  additional  cash  resources.  These  measures  sufficed  ; 
there  was  no  acute  panic.  So  strongly  intrenched  is  the  Bank 
of  England  nowadays,  so  conscious  of  its  obligations  to  the 
public,  so  effectively  secured  by  its  form  of  management  against 
being  itself  entangled  in  dangerous  ventures,  that  it  is  probably 
in  a  position  hereafter  to  cope  with  any  financial  panic  in  its 

1  Precisely  this  was  accomplished  at  Chicago  in  1906,  when  a  threatened 
panic  was  staved  off  in  the  manner  described.  For  purposes  of  this  sort,  the 
Federal  Reserve  Banks  may  be  expected  to  replace  or  supplement  clearing  house 
associations.  *  Chapter  26,  §  3. 

2E 


418   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

own  country.  It  is  not  indeed  able  to  control  the  periodic  oscil- 
lations of  industry,  and  the  painful  revulsions  from  activity  to 
depression ;  but  it  has  learned  how  to  deal  with  the  acute  stage 
which  hitherto  has  so  commonly  marked  the  transition,  and 
which  has  intensified  so  much  its  ill  effects.  To  prophecy 
that  acute  financial  distress  will  never  recur  in  England,  would 
be  unsafe;  but  the  unreasoning,  moblike  panic  has  become 
highly  improbable. 

§  4.  In  the  United  States,  the  other  great  deposit  banking 
country,  there  was  nothing  in  the  experience  of  the  last  genera- 
tion to  indicate  that  the  financial  panic  was  a  thing  of  the  past. 
The  situation  was  in  many  ways  different  from  that  in  England, 
and  in  many  ways  contained  greater  elements  of  danger. 

The  national  banks  of  the  reserve  cities,  and  especially  those 
of  New  York,  occupied,  it  is  true,  a  position  analogous  to  that  of 
the  Bank  of  England.  But  the  analogy  did  not  reach  far. 
They  were  many  in  number,  and,  though  combined  for  some 
purposes  in  the  Clearing  House  Associations,  they  could  not  act 
with  the  energy  and  promptness  of  a  single  institution.  Even 
if  they  had  been  organized  to  act  unhesitatingly,  they  were  not 
in  a  position  to  give  all  the  assurance  and  support  that  were 
needed.  Their  reserves  of  cash  were  only  such  as  the  national 
banking  laws  compelled ;  sometimes  a  little  more,  but,  at  the 
times  when  panics  were  Jikely,  seldom  appreciably  more.  Not 
least,  they  were  themselves  not  above  suspicion.  Most  banks,  it  is 
true,  are  always  solvent  and  even  super-solvent.  But  there  are 
commonly  some  black  sheep,  with  rumors  and  suspicions  of 
more.  Banks  in  general,  solvent  or  not,  are  uneasily  conscious 
that  they  have  not  an  invulnerable  position:  it  necessarily 
ceases  to  be  so  when  public  confidence  begins  to  be  shaken. 

To  these  causes  of  danger  was  added  the  fact  that  deposit 
banking  is  extraordinarily  widespread.  Not  only  is  the  total 
volume  of  deposits  in  the  United  States  very  great,  but  the 
number  of  individual  banks  and  of  individual  depositors  is  enor- 
mous. There  is  a  larger  proportion  than  in  England  of  persons 
who  are  likely  to  be  affected  by  unreasoning  panic.  Deposit 


FINANCIAL   PANICS  419 

accounts  are  kept  not  only  by  those  doing  business  on  a  consider- 
able scale  and  by  persons  of  large  means,  but  by  petty  retail 
tradesmen,  farmers,  women.  These  easily  get  into  a  fright  when 
some  great  bank  fails  and  rumors  are  flying  thick  about  others. 
An  overt  run,  or  a  silent  steady  withdrawal  of  cash,  may  then  be 
precipitated.  The  banks,  on  the  other  hand,  are  scattered,  are 
sensitive  to  the  possibility  of  sudden  demands,  and  are  them- 
selves by  no  means  free  from  panicky  feeling.  Many  of  them 
are  small ;  many,  large  and  small,  conduct  their  operations  in 
ordinary  times  with  a  minimum  of  cash.  When  danger 
threatens,  they  telegraph  urgently  for  cash  to  the  reserve  bank  in 
which  they  keep  a  deposit.  They  do  so  not  only  to  meet  real 
drains  by  their  own  depositors,  but  to  provide  against  possible 
or  anticipated  drains.  Among  the  banks,  as  among  their  in- 
dividual depositors,  a  spirit  of  sauve  qui  pent  may  develop; 
and  then  a  full-fledged  panic  bears  forth. 

The  provision  in  the  national  banking  laws  by  which  country 
banks  might  count  as  reserve  for  themselves  what  they  kept  on 
deposit  in  reserve  cities  probably  increased  the  dangers  of  the 
situation.  As  has  already  been  said,  this  provision  was  by  no 
means  the  sole  cause  or  the  main  cause  of  the  concentration  of 
cash  holdings  and  of  final  responsibility.  Some  concentration 
of  this  sort  is  inevitable,  and  indeed  makes  for  the  more  economi- 
cal and  efficient  working  of  deposit  banking.  But  the  reserve 
regulations  under  the  national  banking  system  operated  as  an 
additional  inducement  to  the  scattered  banks  to  keep  deposits 
(on  interest)  in  the  central  cities,  and  thus  intensified  the  drain 
on  these  in  times  of  stress. 

The  device  to  which  the  banks  of  the  United  States,  especially 
those  of  the  large  cities,  and  above  all  those  of  New  York  City, 
turned  at  such  times,  was  that  of  combining  their  reserves  by 
resorting  to  clearing  house  certificates.  These  were  a  sort  of 
currency,  issued  under  the  supervision  of  the  clearing  house  or- 
ganization to  the  individual  banks  and  used  for  settlements 
among  themselves.  A  bank  which  found  itself  pressed  went  to 
the  authority  constituted  for  the  emergency  (usually  a  small 


committee  representing  the  clearing  house  banks),  and  pledged 
some  of  its  assets,  —  securities  or  mercantile  paper.  It  then 
received  certificates  in  convenient  (large)  denominations,1 
which  could  be  used  in  settling  balances  at  the  clearing  house. 
On  these  certificates  interest  was  paid  by  the  bank  which  took 
them  out,  usually  at  a  high  rate  (seven  per  cent,  or  thereabouts) ; 
the  interest  being  paid  directly  to  the  clearing  house  committee, 
and  through  this  to  the  bank  receiving  the  certificates  in  settle- 
ment. The  effect  was  to  leave  the  cash  held  by  the  banks  free 
for  use  in  paying  depositors,  —  whether  local  depositors  or  banks 
in  other  places.  Its  effect  was  also  to  facilitate  defense  for  any 
one  bank  exposed  to  a  run.  Other  banks  could  turn  over  to  it, 
by  way  of  loan,  some  of  their  cash,  and  this  could  be  paid  out 
freely  to  frightened  depositors.  Quite  as  often,  however,  the 
defensive  effect  was  indirect.  A  depositor,  even  though  uneasy, 
often  hesitates  to  go  to  the  counter  and  demand  cash  directly. 
He  draws  a  check  in  favor  of  a  friend,  and  has  the  sum  deposited 
by  the  friend  in  some  other  more  trusted  bank.  Such  a  check, 
then,  was  met  at  the  clearing  house  by  certificates ;  that  is,  it  was 
met  virtually  by  a  pledge  of  the  bank's  assets  other  than  cash. 
The  clearing  house  certificate  plan,  however,  proved  quite 
inadequate  to  prevent  a  breakdown  of  the  American  deposit 
system.  It  served  to  mitigate  or  prevent  some  minor  dis- 
turbances; but  on  three  conspicuous  occasions,  in  1873,  in 
1893,  in  1907,  complete  collapse  ensued  notwithstanding  its  use. 
In  each  of  these  great  panics  the  banks  of  the  country  virtually 
suspended  payments.  Thereby  they  committed  acts  of  bank- 
ruptcy, and  under  the  strict  letter  of  the  law  could  have  been 
forced  into  liquidation.  The  fact  that  the  suspension  was  uni- 
versal and  well-nigh  inevitable,  caused  its  strict  legal  conse- 
quences to  be  ignored ;  and  after  a  few  weeks  or  months  the 
usual  course  of  payments  was  resumed.  But  during  these 
weeks  and  months,  on  all  three  occasions,  legal  obligations 

1  The  amount  of  clearing  house  certificates  was  usually  less  (80  per  cent  or 
thereabouts)  than  the  face  value  of  the  commercial  paper  or  the  market  value  of 
the  securities. 


FINANCIAL  PANICS  421 

were  put  aside.  Neither  individual  depositors  nor  outside 
banks  could  get  the  cash  which  they  had  the  right  to  demand. 
No  doubt  their  demands  were  in  one  sense  unreasonable. 
Individuals  called  for  cash  because  they  wished  to  hoard  it, 
by  tucking  it  away  in  drawers  or  in  safe  deposit  boxes.  Out- 
side banks  wanted  it  partly  because  their  own  depositors  made 
similar  demands,  partly  because  they  themselves  were  in  a  fright 
lest  such  demand  should  come.  Whatever  the  cause,  the 
breakdown  was  well-nigh  complete.  A  depositor  in  1893  or 
1907  was  allowed  to  draw  pocket  money  —  a  few  dollars  —  by 
his  bank ;  but  any  demand  for  considerable  sums  was  met,  in 
most  cities  and  by  most  banks,  with  flat  refusal. 

To  describe  the  various  further  consequences  of  these  banking 
collapses  would  carry  us  beyond  the  limits  of  the  present  book. 
In  the  crises  of  1873,  1893  and  1907,  there  was  the  curious  phe- 
nomenon, at  the  height  of  the  disturbance,  of  a  "premium  on  cur- 
rency "  ;  perhaps  described  more  accurately  as  a  depreciation  of 
deposits.  Persons  in  need  of  cash,  or  very  solicitous  to  procure 
cash,  were  willing  to  give,  for  cash,  checks  on  solvent  banks  (checks 
which  were  available,  however,  only  through  the  clearing  house) 
at  an  advance  of  as  much  as  two,  three,  or  four  per  cent.  Even 
more  striking  was  the  large  resort  to  various  substitute  media  of 
exchange,  in  the  form  of  checks  payable  to  bearer  and  of  clear- 
ing house  certificates  in  smaller  denominations.  There  was  a 
literal  scarcity  of  cash,  and  those  who  needed  it,  such  as  em- 
ployers having  large  pay  rolls,  had  to  turn  to  these  cumbrous  sub- 
stitutes. Of  all  the  incidents  of  an  acute  financial  crisis,  that  of 
1907  gave  conspicuous  illustrations,  —  failures  of  some  large  bank- 
ing houses,  shock  to  confidence  in  others,  demands  for  cash  from 
frightened  depositors  and  frightened  banks,  virtual  suspension 
of  cash  payments  in  most  cities,  a  so-called  premium  on  currency, 
sharp  fall  in  the  prices  of  securities  and  staple  commodities.  The 
events  of  1907,  repeating  as  they  did  in  unusual  severity  those 
of  1873  and  1893,  made  it  clear  that  no  effective  way  had  been 
devised  in  the  United  States  to  meet  the  financial  panic. 

The  generic  feature  of  an  acute  crisis,  whether  in  mercantile  com- 


422   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

munity  or  as  regards  the  banks,  is  loss  of  confidence.  Business 
men  lose  confidence  in  the  punctual  meeting  of  their  mutual 
obligations;  the  public  and  the  depositing  banks  themselves 
lose  confidence  in  the  punctual  payment  by  banks  of  their  obliga- 
tions. The  scarcity  of  cash  and  the  high  rates  of  discount  are  a 
result  and  a  symptom,  not  a  cause.  The  remedy  must  be  one 
that  will  restore  confidence.  Only  so  far  as  an  increase  in  the 
supply  of  cash  does  this  is  it  a  remedy.  More  effective  than 
anything  else  is  a  bold  and  liberal  policy  by  the  banks:  free 
offering  of  loans  and  free  offering  of  cash  to  all  who  want  it. 
To  pursue  that  policy,  the  banks  must  not  only  be  strong,  but 
must  have  an  ample  reserve  of  strength,  and  the  ability  to  con- 
vince the  public  that  they  have  it.  The  suspension  of  the  Bank 
Act  by  the  Bank  of  England  —  the  classic  example  of  a  specific 
remedy  for  panics  —  led  on  only  one  occasion  to  the  actual 
issue  of  more  notes.  The  mere  knowledge  that  more  could  be 
got,  and  as  many  more  as  might  be  needed,  sufficed  to  restore 
confidence;  or,  more  accurately,  contributed  to  allay  the  un- 
easiness which  might  have  precipitated  a  full-fledged  panic. 

It  was  the  unhappy  experiences  of  1907  that  led  to  the  cur- 
rency and  banking  system  of  1913.1  The  Reserve  Banks  were 
then  deliberately  created  as  institutions  whose  main  object  was 
to  serve  and  safeguard  the  public.  They  were  expected  to  main- 
tain large  cash  reserves,  to  extend  prompt  aid  to  individual 
banks  which,  though  solvent,  might  be  imperilled  by  runs,  and 
to  prevent  general  panic  by  ready  loans  and  abundant  cash. 
The  authority  to  issue  additional  notes,  with  no  limit  except 
such  as  might  be  imposed  by  the  Federal  Reserve  Board,  put 
them  in  possession  of  an  emergency  resource  that  would  seem 
sufficient  for  every  possible  demand.  Not  the  scale  or  power 
of  the  machinery  provided,  but  the  skill  with  which  it  is  used, 
must  determine  the  efficacy  of  the  system  in  preventing  the 
recurrence  of  such  catastrophes  as  have  darkened  the  past. 

1  An  interim  act  of  1908  had  provided,  pending  the  elaboration  of  the  perma- 
nent system,  for  a  temporary  "emergency  currency,"  to  be  issued  by  the  national 
banks  under  special  conditions.  As  it  happened,  these  were  resorted  to,  and  with 
good  results,  in  the  summer  of  1914,  just  before  the  Federal  Reserve  System 
went  into  operation,  when  the  outbreak  of  the  European  war  threatened  a  panic. 


FINANCIAL  PANICS  423 

§  5.  The  acute  stage  of  a  crisis  does  not  last  long.  A  few 
weeks  of  excitement  and  anxiety,  of  banking  and  mercantile 
collapses,  of  pressing  demand  for  "money"  (i.e.  loans)  at  high 
rates  of  discount,  are  followed  by  rapid  subsidence  and  qui- 
escence. Almost  invariably,  cash  accumulates  in  bankers'  vaults 
within  a  few  months  of  a  panic,  and  the  rate  of  discount  falls  to  a 
low  figure.  These  conditions  hold  for  a  considerable  period, 
longer  or  shorter  according  as  the  revival  of  activity  comes  late 
or  early.  During  this  period  the  banks,  though  willing  and  able 
to  extend  advances,  find  the  business  community  unresponsive, 
and  an  abundance  of  cash  in  their  hands  goes  hand  in  hand  with 
low  and  falling  prices. 

It  might  seem  that  the  panic  proper,  which  is  brief,  must  be  of 
concern  chiefly  to  the  business  and  banking  classes.  But  it  is 
often  followed  by  long-continued  and  widespread  effects;  and 
these  effects,  though  not  due  solely  or  even  chiefly  to  the  panic, 
are  aggravated  by  it.  The  confidence  which  is  restored,  after  a 
few  weeks  or  at  most  months,  is  a  slow  and  sluggish  feeling,  verj^ 
different  from  that  buoyancy  which  marks  the  period  of  activity. 
When,  as  is  commonly  the  case,  the  acute  crisis  comes  as  the 
climax  of  such  a  period  of  activity,  the  reverse  period  of  depres- 
sion is  doubtless  inevitable.  But  the  depression  is  greater  and 
lasts  longer  if  the  panic  has  been  severe.  The  psychological  fac- 
tor again  tells.  Business  men,  after  such  a  serious  trial,  hesitate 
to  engage  in  new  enterprises,  and  are  cautious  in  the  conduct  of 
the  old.  Dealers  and  middlemen  curtail  purchases,  waiting  for 
better  times,  —  partly  from  cold  calculation  of  lowering  prices, 
but  largely  from  the  mere  contagion  of  depression.  Hence 
there  is  less  real  production  of  wealth.  The  process  of  advances 
by  capitalists  to  laborers,  on  which  the  wages  of  hired  work- 
men proximately  depend,  takes  place  less  actively,  and  there 
is  less  employment  of  labor.  Hard  times  are  in  reality  hard,  and 
the  more  so  if  the  panic  which  precipitates  them  has  been 
violent. 

The  period  of  depression  is  often  a  healthy  one,  or  at  least  is 
essential  for  industrial  health.  Sometimes  it  is  complicated  by 


424       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

other  than  the  ordinary  or  normal  causes,  and  brings  to  end  real 
evils  and  real  difficulties  of  a  different  origin.  Thus,  in  the 
United  States,  inflation  of  the  currency  through  irredeemable 
or  quasi-irredeemable  paper  has  intensified  some  periods  of  ex- 
pansion, and  the  return  to  a  sound  currency  has  been  a  part  of 
the  subsequent  periods  of  depression.  The  sharp  crises  of  1818 
and  1837  came  as  the  climax,  not  only  of  general  speculative 
activity,  but  of  excessive  issues  of  notes  by  scattered  and  ill- 
regulated  banks.  The  return  to  a  stable  currency  was  essential 
to  restored  industrial  health,  but,  coming  as  it  did  with  the 
general  readjustment  of  a  period  of  depression,  was  inevitably 
trying.  Something  of  the  same  sort  is  true  (for  the  United 
States)  of  the  crisis  of  1873.  The  collapse  after  1873  and  the 
severe  fall  of  prices  were  part  of  the  process  by  which  the  return 
to  specie  payments  was  brought  about.  And  even  without  these 
extraneous  circumstances,  the  period  of  depression  which  follows 
a  crisis  is  often  in  reality  invigorating.  It  restores  the  proper 
balance  of  the  different  parts  of  the  industrial  organism.  The 
period  of  activity,  on  the  other  hand,  is  often  one  of  prosperity 
in  appearance  more  than  in  reality.  It  means  a  false  start, 
a  pace  which  cannot  be  maintained.  And  through  all  these  ups 
and  downs,  the  fundamental  forces  which  make  for  material 
advancement  continue  to  have  their  steady  and  half-unperceived 
effects :  the  progress  of  invention  and  the  increase  of  capital, 
the  accumulation  of  savings,  the  industrial,  intellectual,  and 
moral  advancement  of  the  workers.  Too  much  attention  is 
commonly  given  to  the  more  obvious  phenomena  of  superficial 
prosperity,  to  good  times  and  hard  times,  and  too  little  to  the 
great  factors  on  which  in  the  long  run  depends  the  improve- 
ment of  the  condition  of  mankind. 

None  the  less,  it  is  true  that  panics  are  bad  in  themselves, 
and  bad  in  their  after  effects.  A  violent  crisis  prolongs  the  sub- 
sequent period  of  depression,  or  at  least  makes  it  more  severe. 
The  worse  the  shock,  the  harder  the  recovery.  Anything 
which  can  be  done  to  mitigate  the  financial  panic  contributes  to 
mitigate  the  depression  of  the  industrial  crisis. 


FINANCIAL  PANICS  425 

§  6.  Remedies  or  at  least  palliatives  for  the  financial  panic  are 
easier  to  find  than  those  for  the  larger  cycles  of  industrial  depres- 
sion. A  currency  anchored  securely  to  a  specie  bottom,  and  a 
well-devised  banking  system,  with  effective  provision  for  meeting 
emergencies,  —  these  are  the  best  means  for  coping  with  the 
financial  panic.  They  have  been  reasonably  perfected  hi  the 
leading  European  countries ;  and  after  long  and  troublous  'ex- 
perience, a  promising  mechanism  has  been  devised,  in  the 
Federal  Reserve  system,  for  the  United  States  also. 

For  the  grave  evils  which  flow  from  the  industrial  aspects  of 
crises  it  is  much  harder  to  find  a  remedy.  Something  may 
be  gained  by  diffusion  of  better  education  among  the  classes  from 
whom  business  men  are  recruited.  The  excitement  and  demor- 
alization, the  psychological  factors,  which  play  so  considerable 
a  part,  rest  largely  on  ignorance.  Business  men,  though  well  in- 
formed of  what  goes  on  in  the  circle  of  their  immediate  operations, 
are  often  singularly  ignorant  on  the  wider  aspects  of  industry 
and  on  the  economic  history  which  records  the  warning  experi- 
ence of  the  past.  Something  may  be  gained,  too,  by  direct  gov- 
ernment action.  It  has  been  suggested  that  large  public  works, 
in  the  way  of  roads,  buildings,  harbor  works,  parks,  public  im- 
provements of  all  sorts,  should  be  undertaken  most  actively  in 
periods  of  depression,  and  held  back  during  periods  of  activity, 
thus  counteracting  to  some  degree  the  alternations  of  private  in- 
vestment. Public  activity  has  tended  in  the  past  to  proceed 
just  the  other  way,  it  has  accelerated  or  slackened  its  pace  sym- 
pathetically with  private  activity.  Where  great  industries,  such 
as  the  railways,  are  under  public  management,  the  opportuni- 
ties for  some  kind  of  check-weighing  may  seem  to  be  present  to  a 
special  degree.  But  it  is  by  no  means  clear  how  far  public  ac- 
tion of  this  sort  can  be  made  an  efficient  palliative :  for  public 
works  undertaken  not  with  an  eye  to  clearly  perceived  needs, 
but  with  a  view  to  general  effects  on  industry  and  employment, 
are  likely  to  be  ill-conducted,  and  so  in  the  end  unsuccessful 
and  themselves  irregular. 

In  the  main,  oscillations  of  industry  must  be  accepted  as  in- 


426       MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

evitable  concomitants  of  the  regime  of  private  property.  They 
may  be  mitigated,  but  they  are  not  likely  to  cease.  They  are 
part  of  the  price  which  must  be  paid  for  that  progress  which 
private  ownership  and  employing  capitalism  secure.  No  doubt 
they  are  among  the  black  features  of  the  existing  system. 
Helpless  embarrassment,  halting  production,  hardship  and  suffer- 
ing for  the  unemployed  laborers  —  these  are  held  up  by  the 
socialist  critics,  not  without  show  of  reason,  as  damning  facts. 
A  systematically  organized  scheme  of  production  would  preclude 
these  evils.  But  deliberate  planning  of  industry,  carried  out 
universally  —  and  this  means  socialism  —  would  lack  also  the 
vigor,  the  elasticity,  the  forward  movement  which  mark  existing 
industry.  Here,  as  in  all  things  human,  and  certainly  in  all 
economic  arrangements,  no  ideal  perfection  can  be  looked  for. 
Good  must  be  balanced  against  ill,  and  that  mode  of  con- 
ducting industry  must  be  accepted  which  brings  the  greatest 
attainable  gain,  even  though  it  bring  in  its  train  also  no  small 
amount  of  loss. 


CHAPTER  31 

THE  THEORY  OF  PRICES  ONCE  MORE 

§  1.  We  return  now  to  the  main  topic  of  monetary  theory: 
the  relation  of  the  quantity  of  money  to  prices,  and  the  causes 
that  determine  the  general  level  of  prices.  It  was  explained  at  the 
beginning  of  the  present  Book  l  that,  under  the  simplest  condi- 
tions, prices  vary  exactly  with  the  quantity  of  money;  but 
it  was  said  that  this  proposition  required  great  qualifications 
under  any  except  the  simplest  conditions.  The  nature  of  these 
qualifications  and  the  more  refined  general  formulation  of  the 
theory  we  are  now  prepared  to  consider. 

At  the  outset,  something  must  be  said  of  the  relation  of 
credit  to  prices.  This  again,  we  may  analyze  by  taking  up 
first  the  simplest  conditions. 

A  purchase  on  credit  has  the  same  immediate  effect  on  prices 
as  a  purchase  with  cash.  If,  in  addition  to  a  given  number  of 
purchasers  offering  money,  there  are  as  many  more,  whose  credit 
is  good,  offering  to  buy  on  time,  the  effect  on  the  seller  is  the 
same  as  if  the  entire  number  offered  money.  With  a  fixed  sup- 
ply of  commodities,  prices  would  double  in  either  case. 

But  this  is  only  the  proximate  effect.  Sooner  or  later,  the  goods 
bought  on  credit  must  be  paid  for.  When  they  are  paid  for, 
money  must  be  used.  Credit  per  se  does  not  permanently  dis- 
pense with  the  use  of  money  in  payments;  it  only  postpones 
the  use  of  money.  At  the  later  date,  when  the  debt  comes  to 
be  paid,  money  will  be  used,  and  what  money  is  so  used  will  not 
be  available  for  other  sorts  of  transactions.  To  the  extent  that 
money  is  dispensed  with  at  the  outset,  to  that  extent  more  of 
it  is  called  for  in  the  end.  In  the  long  run,  therefore,  credit 
stands  for  no  independent  factor  in  the  determination  of  prices, 

1  See  above,  Book  III,  Chapter  1& 
427 


428   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

and  is  no  real  substitute  for  money,  —  no  real  cause  of  addition 
to  the  monetary  demand  for  commodities.  It  simply  affects 
the  time  when  the  money  shall  pass. 

For  a  period,  however,  an  extension  of  credit  may  have  the 
same  effect  on  prices  as  a  corresponding  increase  in  the  quantity 
of  money.  In  the  great  pendulum  swings  of  modern  industry, 
there  are  apt  to  be  intervals  of  considerable  length  —  a  year  or 
two,  perhaps  more  —  when  new  purchases  on  credit  are  made 
more  freely  than  payments  on  account  of  earlier  purchases  take 
place.  During  such  a  period  credit  operations  act  to  raise 
prices,  by  the  difference  between  the  volumes  of  the  two  sets  of 
transactions.  In  times  of  depression  there  is  the  reverse  situa- 
tion, —  hesitancy  in  purchases  and  contraction  of  credit  deal- 
ings. Then  the  payments  of  old  debts  exceed  the  new  purchases 
on  credit,  and  the  balance  sinks  the  other  way .  Shifts  like  these, 
though  probably  not  of  great  consequence,  play  some  part  in 
bringing  about  the  oscillating  tendency  of  price  movements. 

§  2.  The  extension  of  credit,  however,  may  cause  not  merely 
a  postponement  of  the  use  of  money.  It  may  bring  into  action 
a  train  of  causes  enabling  money  to  be  dispensed  with.  If,  for 
instance,  a  merchant  of  high  standing  buys  goods,  and  gives  his 
promissory  note  in  payment,  the  transaction  per  se  merely  puts 
off  the  use  of  money  until  the  maturity  of  the  note.  Conceiv- 
ably, however,  the  holder  of  the  note  may  turn  it  over,  with  his 
indorsement,  to  another  person,  in  payment  of  goods.  If  that 
other  person  accepts  it,  the  use  of  money  in  the  second  trans- 
action is  entirely  obviated :  yet  the  effect  on  prices  is  precisely 
the  same  as  if  so  much  money  had  actually  passed.  It  is  further 
conceivable  that  the  second  person  may  hand  over  the  note  in 
place  of  money  in  still  another  purchase.  In  the  first  part  of  the 
nineteenth  century,  this  sort  of  circulation  of  the  promissory 
notes  or  acceptances  1  of  individuals  seems  to  have  been  not  un- 
common in  England. 

1  An  acceptance  of  a  bill  of  exchange  or  draft  brings  in  law  the  same  sort  of 
obligation  as  the  signing  of  a  promissory  note.  For  reasons  that  root  in  legal  his- 
tory, acceptance  of  a  bill  has  been  much  the  more  common  form  in  England. 


THE  THEORY  OF  PRICES  ONCE  MORE  429 

Obviously  bank  notes  supply  the  most  complete  instance  of 
this  effect  of  a  credit  instrument.  The  note  of  an  individual, 
given  in  the  ordinary  course  of  transactions,  can  hardly  circulate 
much,  however  well  known  and  reputed  he  may  be ;  for  only  by 
an  accident  can  it  be  of  convenient  denomination  for  other  deal- 
ings. But  bank  notes,  —  which  may  be  issued  by  an  individual 
as  well  as  by  a  corporation,  unless  there  be  legal  restriction, 1 — 
are  intentionally  made  out  in  denominations  for  convenient  cir- 
culation, and  pass  from  hand  to  hand  as  money  would.  The 
effect  of  this  form  of  credit  is  not  open  to  question.  Bank  notes 
serve  as  complete  substitutes  for  money,  and  affect  prices  as 
much  (barring  some  qualifications  to  be  noted  presently)  as 
specie  would. 

Quite  a  different  way  in  which  credit  enables  money  to  be  dis- 
pensed with  is  in  the  possibility  of  enabling  transactions  to  be 
offset. 

If  a  country  dealer  sells  merchandise  on  credit  to  the  sur- 
rounding farmers,  and  the  farmers  in  turn  bring  their  produce  to 
the  dealer,  and  hand  it  over  to  him  on  credit ;  and  if  periodically 
the  debts  are  offset,  and  only  the  balance  is  paid  (that  balance 
perhaps  allowed  to  stand  over  as  an  item  for  the  next  succeeding 
settlement),  though  little  money  passes,  the  transactions  are  all  in 
terms  of  money,  and  prices  are  affected  as  if  money  had  passed. 
Such  offsetting  transactions  were  probably  common,  in  many 
parts  of  the  United  States,  in  the  earlier  stages  of  industrial  de- 
velopment. In  parts  of  New  England  eggs  are  still  regularly 
received  by  village  storekeepers  from  the  country  folk,  and  cred- 
ited to  these  against  purchases ;  a  sort  of  barter,  but  one  taking 
place  in  terms  of  money,  and  with  a  legal  obligation  on  each  side 
to  pay  money.  But  with  the  specialization  of  mercantile  deal- 
ings such  practises  have  almost  disappeared.  The  dealer  who 
buys  is  rarely  the  identical  person  to  whom  sales  are  made.  The 
far  developed  division  of  labor,  here  as  elsewhere,  has  caused 

1  It  may  be  noted  that  in  China  merchants'  notes,  payable  to  bearer,  have 
been  in  use  (apparently  for  centuries)  as  a  circulating  medium.  "They  are 
issued  by  the  great  houses  of  business  and  are  accepted  in  all  the  principal 
towns."  Hue's  Chinese  Empire,  Vol.  II,  p.  151. 


430       MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

exchanges  which  are  fundamentally  simple  to  be  carried  on  by 
a  divided  and  complicated  mechanism.1 

The  great  and  effective  mechanism  which  serves  to  bring 
scattered  exchanges  to  a  single  focus,  and  enables  the  offsetting 
of  debts  to  be  carried  out  on  a  large  scale,  is  that  of  the  clearing 
house.  The  checks  turned  in  by  a  bank  are  offset  by  the  checks 
presented  against  it.  In  the  purchases  which  have  been  settled 
by  the  checks  prices  have  been  affected  precisely  as  if  specie  had 
passed  at  the  time  of  the  purchase.  At  the  clearing  house  the 
checks  are  simply  exchanged.  The  transactions  are  settled  in 
the  end  without  any  use  of  specie  or  cash,  or,  to  be  more  ac- 
curate, with  only  a  slight  use  of  it,  —  in  that  small  proportion 
in  which  clearing  house  balances  are  settled  with  cash. 

The  same  result,  of  course,  is  attained  when  bank  notes  go 
through  the  clearing  house.  But  bank  notes  are  more  likely 
than  checks  to  perform  transactions  on  the  way,  passing  from 
hand  to  hand  repeatedly  in  payments.  Checks  commonly  go  at 
once  to  some  bank  of  deposit,  and  thence  are  sent  to  the 
clearing  house ;  and  they  obviate  the  use  of  money  almost  ex- 
clusively through  the  offsetting  process. 

§  3.  We  may  proceed  now  to  the  more  refined  and  accurate 
statement  of  the  relation  between  quantity  of  money  and  prices. 

What  determines  prices  in  a  highly  developed  community  is 
the  relation  between  the  quantity  of  goods  and  the  quantity  of 
purchasing  power  in  terms  of  money.  Formulated  in  this  way, 
the  quantity  theory  holds  good.  It  is  strictly  true  that  the  gen- 
eral range  of  prices  depends  —  the  quantity  of  things  on  sale 
being  given  —  on  the  volume  of  purchasing  power  in  terms 
of  money.  But  that  volume  is  by  no  means  the  same  as  the 
volume  of  specie  or  of  what  is  generally  termed  "money."  And 

1  In  one  case,  of  no  small  importance,  such  direct  offsetting  of  debts  does  take 
place  on  a  large  scale,  namely,  through  the  stock  exchange  clearings  in  New 
York.  Here  a  number  of  dealers  (the  stock  exchange  brokers)  buy  and  sell  to 
each  other  great  amounts  of  securities,  and  settle  their  transactions  very  largely 
by  a  process  of  offsetting.  There  is  a  clearing  system  on  the  Chicago  Board  of 
Trade  also,  but  it  seems  to  be  made  use  of  only  to  a  limited  extent.  See  Report 
of  the  Chicago  Board  of  Trade,  1907,  pp.  Ill,  112. 


THE  THEORY  OF  PRICES   ONCE  MORE  431 

the  really  difficult  and  controverted  question  is  how  far  an  in- 
crease or  decrease  in  the  quantity  of  specie  or  "money"  affects 
this  other  quantity,  total  purchasing  power. 

Some  things  are  obvious.  Certain  sorts  of  paper  substitutes 
for  specie  operate  precisely  as  specie  does.  Notes  payable  to 
bearer,  and  government  paper  pieces  whether  convertible  or  in- 
convertible, add  by  the  amount  of  their  face  value  to  the  total 
purchasing  power.  Such  things  are  included  in  common  usage 
under  the  term  "money,"  and  are  admitted  on  all  hands  to  in- 
fluence prices  virtually  as  specie  does.  This  is  obviously  the 
case  also  with  such  bank  notes  as  those  of  the  Bank  of  England. 
It  is  very  largely  the  case  with  our  national  bank  notes,  and  with 
other  bank  notes  also  ;  though  it  is  not  so  clear,  in  these  cases, 
that  there  is  a  net  increase  of  purchasing  power  by  the  face 
value  of  the  note. 

Credit  also  adds  to  the  supply  of  purchasing  power.  An  offer 
to  buy  goods,  by  a  man  whose  credit  is  undoubted,  acts  on  their 
price  just  as  much  as  an  offer  by  one  who  proffers  cash.  But 
credit,  as  has  just  been  explained,  serves  in  its  ordinary  form 
merely  to  postpone  the  use  of  money.  Though  it  may  add  to 
the  total  of  effective  purchasing  power  at  a  given  time,  in  the 
long  run  it  brings  no  increase  of  the  total. 

Deposits  constitute  part  of  the  total  purchasing  power ;  and 
an  increase  of  deposits  means  an  increase  in  the  total.  Deposits, 
be  it  noted,  —  not  checks ;  for,  as  has  been  said  already,1  checks 
simply  represent  this  power  in  actual  exercise,  not  the  total  avail- 
able supply.  The  total  supply  of  purchasing  power  in  terms  of 
money  thus  consists  of  various  and  heterogeneous  items ;  but  all 
forms  of  it  add  to  that  monetary  demand  for  goods  which  deter- 
mines the  level  of  prices. 

The  most  intricate  question  is  presented  by  deposits.  A  pur- 
chase of  goods,  the  discount  of  commercial  paper,  the  creation 
of  deposits,  —  all  these  go  together.  The  very  increase  in  the 
quantity  of  goods  and  in  the  volume  and  transactions  brings 
with  it  an  increase  in  total  purchasing  power  and  in  the  effective 

i  See  Book  III,  Chapter  8,  §  3. 


432   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

machinery  of  exchange.  The  statement  of  a  quantity  theory  in 
relation  to  prices  assumes  two  independent  variables :  total 
money  or  total  purchasing  power  on  the  one  hand,  total  supply 
of  goods  or  total  volume  of  transactions  on  the  other.  But  in 
the  case  of  deposits  these  two  factors  seem  to  be  mutually  de- 
pendent, and  the  underlying  assumption,  therefore,  seems  not 
to  hold. 

The  same  problem  arises  as  to  bank  notes,  where  these  are  is- 
sued under  condition  of  freedom  and  elasticity.  They,  too,  seem 
not  to  be  an  independent  variable.  They  are  issued  in  response 
to  a  demand  in  the  form  of  more  commodities  to  be  sold.  The 
issues  of  the  Bank  of  France,  the  Bank  of  Germany,  the  Scotch 
and  Canadian  banks,  fluctuate  from  week  to  week  according  as 
more  or  less  transactions  are  to  be  effected. 

On  the  other  hand,  the  volume  of  deposits  (and  in  some 
degree  of  notes),  thus  affected  by  the  very  volume  of  com- 
modities and  of  transactions,  is  not  necessarily  dependent  on 
the  specie  or  other  reserve  money  held  by  the  banks.  One 
might  suppose  the  extreme  case  of  a  community  in  which  all 
payments  were  made  by  check,  and  all  transactions  settled 
through  the  clearing  house.  Here  there  would  be  no  need 
whatever  of  specie  or  "money."  Daily  or  weekly  balances  at 
the  clearing  houses  could  be  allowed  to  stand  over,  and  sooner 
or  later  would  be  equalized.  In  such  a  community,  if  deposits 
swelled  more  rapidly  than  commodities  and  transactions,  prices 
might  rise  indefinitely.  Now,  where  deposits  (or  notes)  are 
very  largely  used,  is  there  not  an  approximation  to  some  such 
condition?  and  can  there  be  said  to  be  any  dependence  of 
prices  on  the  quantity  of  specie  or  of  what  is  usually  termed 
"money"? 

§  4.  Though  it  is  true  that,  where  these  highly  elastic  credit 
instruments  are  used,  the  connection  between  the  total  pur- 
chasing power  and  the  quantity  of  "money"  becomes  at  any 
given  time  very  loose,  there  remains  in  the  long  run  a  real 
limitation  on  these  instruments  in  the  quantity  of  specie. 
This  limitation  comes  in  two  ways :  first,  in  various  links  of 


THE  THEORY  OF  PRICES  ONCE  MORE  433 

connection  between  the  volume  of  deposits  (and  of  notes 
elastic  like  deposits)  and  the  quantity  of  specie;  second,  in  a 
connection  between  prices  in  any  one  country  and  prices  in 
the  world  at  large.  For  the  present,  we  shall  give  attention 
chiefly  to  the  first  set  of  factors ;  the  second  connect  themselves 
with  the  theory  of  international  trade,  to  be  considered  shortly. 

The  extent  of  the  superstructure  of  deposits  and  notes  built 
upon  the  foundation  of  a  given  supply  of  cash  (meaning  by  cash, 
not  only  specie,  but  all  legal  tender  paper  and  other  public 
paper  available  as  reserve)  is  affected  by  the  following  circum- 
stances :  (a)  direct  necessity,  (6)  binding  custom,  (c)  legal  re- 
quirement, (d)  the  interaction  in  the  use  of  deposits,  notes, 
and  other  constituents  of  the  circulating  medium,  (e)  the 
temper  of  the  business  classes.  Let  these  be  considered  in 
order. 

(a)  Direct  necessity.  Some  cash  every  bank  must  have,  even 
though  the  amount  may  be  small  in  proportion  to  liabilities. 
The  figure  of  five  per  cent  has  been  mentioned  in  the  preced- 
ing pages.  Some  such  minimum  a  bank  must  keep.  Even 
less,  four  per  cent,  or  three,  is  occasionally  found  to  serve  the 
purpose;  though  few  banks  would  wish  long  to  sail  so  very 
close  to  the  wind.  But  somewhere  there  is  a  limit. 

That  limit  tends  for  one  reason  to  be  lower  for  a  city  bank 
than  for  a  country  bank,  for  another  reason  to  be  higher.  A 
large  city  bank  is  less  likely  to  have  heavy  proportional  balances 
to  meet  at  the  clearing  house ;  for  its  daily  deposits  from  cus- 
tomers are  more  likely  to  equal  the  daily  drafts  through  cus- 
tomers' checks.  Similarly,  the  daily  calls  for  cash  over  the 
counter  from  customers  are  more  likely  to  be  equaled  by  daily 
deposits  of  cash  over  the  counter.  The  mere  fact  that  its  busi- 
ness is  large  and  varied  makes  it  more  probable  that  such  items 
will  compensate  each  other.  On  the  other  hand,  the  city 
bank  is  under  stronger  pressure  to  hold  a  safety  reserve,  —  an 
extra  store  of  cash  against  emergencies.  The  great  volume  of 
its  deposit  liabilities  makes  it  sensitive  to  runs  or  panics.  The 
display  of  an  extra  store  of  cash  may  add  to  its  repute,  and  so 

2F 


434       MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

may  indirectly  prove  profitable.  Yet  it  does  not  necessarily 
conduce  to  profit :  the  eventual  gain  from  a  high  prudential 
reserve  depends  on  the  temper  and  watchfulness  of  the  business 
public.  It  is  by  no  means  a  universal  experience  among  the 
banks  of  the  United  States  that  this  sort  of  conservatism  is 
a  profitable  advertisement. 

Where  a  city  bank  can  turn  to  a  great  public  institution  for 
support  in  case  of  runs,  its  motive  for  holding  extra  cash  dis- 
appears. It  is  then  like  the  country  bank  which  relies  on  the 
city  bank  in  such  contingencies.  Hence  the  English  banks, 
which  have  the  Bank  of  England  to  fall  back  on,  have  virtually 
given  up  holding  any  safety  reserve;  the  old  lady  in  Thread- 
needle  Street  attends  to  this.  But  some  cash  for  daily  needs, 
even  though  it  be  only  a  little,  they  still  have  to  keep  on  hand. 

(6)  Of  the  binding  force  of  custom,  the  Bank  of  England 
supplies  the  most  obvious  example.  Its  great  reserve  of  cash, 
on  which  rest  not  only  its  own  deposits,  but  those  of  all  Great 
Britain,  is  fixed  by  a  custom  now  as  strong  as  law.  A  similar 
settled  conservatism  affects  the  reserve  against  note  issues 
held  by  the  Bank  of  France,  the  Bank  of  Germany,  and  the 
other  public  banks  of  the  Continent.  The  same  policy,  it 
may  be  safely  asserted,  would  be  adopted  with  regard  to  their 
deposit  liabilities  if  these  should  develop  on  the  same  scale  as 
those  of  English-speaking  countries. 

(c)  Direct  regulation  by  law  is,  as  we  have  seen,  peculiar  to  the 
United  States.  If  all  banks  were  required  to  keep  a  cash  re- 
serve of  twenty-five  per  cent,  as  were  formerly  the  national 
banks  of  New  York  City,  deposits  could  grow  only  in  the  pro- 
portion of  four  to  one  of  cash.  This  was  far  from  being  the 
limitation  in  fact  imposed  on  the  national  banks  as  a  whole ;  but 
there  was,  none  the  less,  a  substantial  limitation.  The  deposits 
could  not  swell  without  some  proportional  increase  of  cash  re- 
quired for  the  legal  reserve.  A  similar  restriction  remained, 
in  the  manner  already  explained,1  when  the  system  was  modi- 
fied through  the  establishment  of  the  Federal  Reserve  Banks. 

1  See  Chapter  27,  section  2. 


THE  THEORY  OF  PRICES  ONCE  MORE          435 

In  judging  of  the  consequences  of  such  regulation,  regard 
must  be  had  not  only  to  the  institutions  directly  affected  but 
to  the  credit  system  as  a  whole.  A  great  growth  of  state  banks 
took  place  during  the  later  years  of  the  old  national  banking 
system.  These  kept  very  slender  cash  resources,  using  the 
national  banks  as  depositories.  The  foundation  on  which  the 
superstructure  of  total  deposits  rested  thus  became  proportion- 
ally narrower.  The  same  situation  remained,  and  even  became 
more  marked,  under  the  Federal  Reserve  system ;  since  the 
Reserve  Banks  were  required  to  hold  smaller  proportional  cash 
reserves  than  the  old  national  banks,  and  yet  continued  to  be 
virtually  the  supporters  of  the  state  banks  as  well  as  of  the 
national  banks  themselves.  This  did  not  mean  necessarily  a 
weakening  of  strength;  but  it  did  mean  that  the  same  quan- 
tity of  cash  in  bank  vaults  became  potentially  more  effective 
toward  increasing  the  total  volume  of  purchasing  power. 

§  5.  (d)  The  next  cause  of  limitation  is  a  more  intricate  one. 
Deposits  and  checks  cannot  serve  for  all  transactions.  Cash 
—  that  is,  specie  or  notes  —  must  be  used  for  many  retail 
purchases,  for  payments  of  wages,  for  all  sorts  of  everyday 
payments.  It  is  true  that  checks  are  used  in  the  United  States 
to  an  astonishing  degree  for  transactions  of  all  sorts.  Yet 
pocket  money  is  by  no  means  dispensed  with.  In  England, 
though  checks  are  used  universally  for  wholesale  transactions, 
they  are  used  for  consumers'  payments  by  only  a  comparatively 
small  number  of  the  well-to-do;  coin  or  notes  are  needed  for 
most  retail  dealings  and  for  all  wages  payments. 

Now  no  one  form  or  denomination  of  purchasing  power  is 
able  to  exercise  an  unqualified  influence  on  prices,  if  it  be 
exchangeable  for  other  forms.  Fifty-dollar  bills  or  ten-pound 
notes,  if  put  out  in  greater  quantity  than  needed  for  the  con- 
venient disposal  of  transactions  to  which  they  are  suited,  will 
flow  back  to  the  issuer  for  exchange  into  small  pieces.  If 
indeed  smaller  notes  are  issuable  under  the  same  conditions,  — 
if  bank  notes  of  all  denomination  can  be  issued  as  freely  as 
large  notes  or  deposits,  —  this  back  flow  is  of  no  special  conse- 


436       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

quence.  But  if  the  only  available  smaller  pieces  are  gold 
coins,  the  consequences  are  important.  Then  a  given  amount 
of  coin  must  remain  afloat  somewhere  in  the  community,  and 
the  volume  of  other  monetary  media  has  a  limitation  from 
the  necessary  use  of  that  coin.  We  have  seen  how  effective 
is  a  limitation  of  bank  notes  to  the  large  denominations;  it 
prevents  the  expulsion  of  specie,  and  limits  strictly  the  field 
which  notes  can  occupy.1 

Precisely  the  same  sort  of  limitation  may  be  effective  on 
deposits.  England  supplies  a  simple  example.  No  notes 
under  £5  being  issued,  and  checks  being  used  (by  custom)  for 
large  transactions  only,  sovereigns  are  necessarily  in  everyday 
use.  If  deposits  were  to  swell,  and  a  rise  in  prices  were  to  take 
place  in  consequence,  more  of  gold  coin  would  be  called  for  in 
everyday  transactions.  The  consequent  drain  of  gold  from  the 
banks  would  put  a  prompt  check  on  the  increase  of  deposits. 
The  English  monetary  system  as  a  whole,  with  its  necessary 
circulation  of  gold  coin,  illustrates  the  interconnection  of  the 
different  constituents  of  the  circulating  medium. 

In  the  United  States  the  same  influence  shows  itself,  but  in 
less  simple  and  effective  ways.  Bank  notes  under  five  dollars 
are  prohibited,  and  the  proportion  which  can  be  issued  even  of 
this  size  is  limited.  Moreover,  the  bond-deposit  requirement 
makes  the  issue  of  notes  by  banks  very  far  from  being  free. 
Hence  deposits  cannot  be  supplemented  in  full  by  bank  notes, 
and  to  some  degree  the  same  sort  of  force  is  in  operation  as  in 
England  to  compel  the  circulation  of  other  than  bank  money. 
That  other  money,  however,  is  to  a  very  large  degree,  not  gold, 
but  substitutes  for  it,  —  government  paper  or  overvalued 
silver.  All  this  fiduciary  money  is  maintained  at  equality 
with  gold,  and,  so  far  as  its  effects  on  prices  go,  is  in  almost 
every  respect  the  same  as  so  much  additional  gold.  But  it 
prevents  the  full-value  coin  from  being  in  circulation  in  as 
great  quantity  as  would  otherwise  be  the  case.  Less  of  actual 
gold  coin  is  called  for  in  order  to  fill  the  channels  of  circula- 

i  See  Book  III,  Chapter  24,  §  2. 


THE  THEORY  OF  PRICES  ONCE  MORE  437 

tion  with  duly  apportioned  denominations  of  money,  and  the 
supply  of  gold  is  consequently  a  less  direct  factor  in  the  de- 
termination of  prices. 

This  need  of  specie,  or  its  equivalent,  for  the  common  trans- 
actions of  everyday  life  helps  to  explain  an  odd  phenomenon, 
to  which  reference  has  already  been  made;  namely,  the  com- 
mon complaint  of  scarcity  of  money  at  the  very  times  when 
total  purchasing  power  is  most  abundant  and  prices  are  highest. 
If  an  expansion  of  deposits  and  other  credit  devices  has  caused 
prices  to  go  up,  more  of  everyday  money  is  called  for  at  the 
banks;  for  at  the  higher  prices  more  of  the  smaller  denomi- 
nations is  needed  for  the  convenience  of  exchanges.  Hence 
banks  feel  a  drain  for  cash,  and  they  complain,  and  the  busi- 
ness community  echoes  the  complaint,  that  there  is  not  money 
enough.  The  real  difficulty  is  that  total  purchasing  power  has 
increased,  and  that,  therefore,  there  is  occasion  for  more  use  of 
every  sort  of  money ;  while  at  the  same  time  the  bank  reserves 
on  which  the  swollen  credit  currency  depends  have  become 
proportionately  smaller,  sometimes  even  absolutely  smaller. 

§  6.  (e)  Finally,  the  temper  of  the  business  community  affects 
the  volume  of  deposits.  It  is  not  to  be  supposed  that  there  is 
an  automatic  adjustment  of  deposits  to  cash  in  any  fixed  pro- 
portion, —  four  to  one,  or  ten  to  one,  or  twenty  to  one.  What 
is  true  is  that  when  the  banks  have  comparatively  large  reserves, 
—  larger  than  seem  to  them  worth  while,  under  the  influence 
of  all  the  factors  just  described, — they  lower  their  rate  of  dis- 
count, welcome  every  applicant  for  a  loan,  and  are  more  than 
willing  to  enlarge  loans  and  deposits.  But  very  often  they 
find  it  impossible  to  enlarge  them.  The  business  community 
does  not  respond.  A  familiar  phenomenon,  recurring  with 
remarkable  regularity,  is  that  in  times  of  depression  banks 
have  abundant  reserves,  that  the  money  market  is  easy,  and 
that  none  the  less  loans  are  not  taken.  Conversely,  during 
periods  of  activity,  when  every  one  is  optimistic,  loans  are  in  de- 
mand ;  and  then  the  banks,  though  their  reserves  may  be  near 
the  minimum  and  their  rate  of  discount  high,  not  only  find  it 


438   MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

easy  to  swell  loans  and  deposits,  but  find  it  difficult  to  prevent 
them  from  swelling.  The  psychology  of  the  business  com- 
munity as  a  whole  is  an  important  factor. 

There  was  a  long  controversy,  a  couple  of  generations  ago, 
concerning  the  mode  in  which  bank  notes,  if  they  were  allowed 
to  be  freely  issued,  affected  business  activity  and  rising  prices : 
whether  their  free  issue  had  per  se  a  stimulating  effect,  or 
whether  an  independent  increase  of  activity  was  the  cause 
leading  to  the  larger  issue.  Which,  in  other  words,  was  cause 
and  which  effect?  The  same  question  can  be  raised  as  to  de- 
posits, and  it  is  in  this  form  that  the  question  is  now  an  im- 
portant one  in  English-speaking  countries.  Does  an  increase 
of  deposits  cause  greater  activity  and  higher  prices,  or  does 
greater  activity  cause  an  increase  of  deposits  and  so  bring  in  its 
own  train  the  higher  prices  ?  The  truth  seems  to  be  that  there 
is  an  interaction  of  causes.  When  the  spirit  of  hope  is  pervasive, 
liberal  banking  facilities  nurture  and  stimulate  it;  without 
general  optimism,  such  facilities  lie  unused  and  inoperative. 

Hence  there  is,  over  short  periods,  truth  in  the  proposition 
that  the  very  conditions  which  bring  about  an  increase  in  the 
supply  of  purchasing  power  bring  about  also  an  increase  in  the 
demand;  that  is,  in  the  volume  of  commodities  or  of  trans- 
actions. In  times  of  activity  more  goods  are  produced.  More- 
over those  which  are  produced  pass  from  hand  to  hand  oftener, 

—  there  is  more  buying  and  selling  between  the  various  middle- 
men.    In  other  words,  the  demand  for  money,  or  the  quantity 
of  goods  offered  in  exchanges,  increases.     In  consequence  there 
is  a  greater  resort  to  banks  for  credit  facilities,  a  greater  crea- 
tion of  deposits,  and  so  an  increase  in  the  supply  of  purchasing 
power.     This    double    or    sympathetic    increase    shows    itself 
most  strikingly  as  regards  transactions  on  the  great  exchanges, 

—  the  stock  exchange,  grain  exchange,  cotton  exchange.     Here 
greater  volume  of  sales  goes  pari  passu  with  an  increase  of 
loans  and  deposits  and  greater  clearings  at  the  clearing  houses. 
Something  of  the  same  sort  takes  place  in  ordinary  mercantile 
transactions. 

All  this  holds  good,  however,  only  for  a  while.     In  the  long 


THE  THEORY  OF  PRICES  ONCE  MORE  439 

run,  the  general  relation  between  deposits  and  reserves  works 
itself  out.  The  period  in  which  that  relation  has  no  immediate 
effect  may  indeed  be  a  considerable  one.  During  a  stage  of 
depression,  and  during  the  early  stages  of  a  period  of  rising 
activity,  the  course  of  prices  seems  to  depend  most  on  the 
temper  of  the  banks  and  of  the  business  community.  With- 
out some  basis  of  cash  reserve  the  banks  could  not  indeed 
expand  their  operations;  but  whether  the  basis  be  broad  or 
narrow  seems  to  matter  little.  When  a  period  of  depression 
has  lasted  for  a  time,  hope  begins  to  revive,  at  first  slowly, 
then  more  briskly.  The  low  rates  of  discount  at  the  banks 
are  found  tempting,  and  the  banks  find  it  possible  to  extend 
their  loans.  Business  gradually  becomes  more  active,  more 
goods  are  produced,  and  more  are  sold.  The  upward  move- 
ment, once  begun,  goes  on  crescendo,  until  the  rush  of  a  full 
tide  of  activity  is  reached.  Then  deposits  are  large  as  com- 
pared with  reserves,  money  is  tight,  the  rate  of  discount  is 
high,  and  even  the  rate  of  interest  on  permanent  investments 
shows  a  sympathetic  rise.  The  final  halt  to  the  movement 
commonly  comes  from  a  commercial  panic,  followed  by  another 
period  of  depression,  with  large  bank  reserves  and  low  discount. 

Thus  there  is  only  a  rough  and  uncertain  correspondence  of 
bank  expansion  with  bank  reserves ;  much  play  for  ups  and 
downs  which  have  no  close  relation  to  the  amount  of  cash  in 
bank  vaults,  and  still  less  direct  relation  to  the  amount  of 
money  afloat  in  the  community  at  large.  Where  bank  media, 
whether  in  the  form  of  deposits  or  notes,  are  an  important  part 
of  total  purchasing  power,  the  connection  between  general 
prices  and  the  quantity  of  "money"  is  irregular  and  uncertain. 

§  7.  The  second  of  the  general  forces  which  limit  the  poten- 
tial effect  of  credit  devices,  especially  deposits,  is  found  in  the 
working  of  foreign  trade.  In  the  discussion  of  this  topic, 
something  is  necessarily  anticipated ;  but  the  principles  impor- 
tant for  the  present  purpose  are  simple,  and  need  not  wait  for 
the  full  treatment  of  the  theory  of  international  trade.1 

1  See  the  discussion  of  international  trade  in  the  next  Book,  especially  Chap- 
ters 33  and  34. 


440        MONEY  AND  THE  MECHANISM   OF  EXCHANGE 

When  countries  trade  with  each  other,  using  a  common  me- 
dium of  exchange,  the  level  of  prices  in  one  is  not  independent  of 
that  in  the  others.  The  different  countries  do  not,  indeed,  have 
the  same  prices,  —  of  this,  more  hereafter.  But  the  price  levels 
maintain  themselves  in  the  same  relations.  If  one  country's 
prices  rise  above  its  normal  range,  there  is  a  tendency  for  im- 
ports to  flow  into  it,  and  for  specie  to  flow  out.  And  if  its  prices 
fall  below  the  normal  range,  its  exports  increase  and  specie  flows 
in. 

Now,  as  has  been  repeatedly  pointed  out,  the  wide  use  of  de- 
posits as  a  medium  of  exchange  is  confined  to  the  English-speak- 
ing countries.  On  the  continent  of  Europe  this  sort  of  credit 
machinery  is  comparatively  ineffective.  Though  notes  are  largely 
used,  they  are  by  no  means  put  forth  under  such  conditions  of 
freedom,  or  with  such  potential  effects,  as  deposits  in  England 
and  the  United  States.  Hence  the  connection  between  total  pur- 
chasing power  and  the  volume  of  tangible  money  —  specie  and 
obvious  paper  substitutes  —  is  much  closer  on  the  Continent. 
The  simpler  form  of  the  quantity  theory  comes  much  nearer  to  fit- 
ting the  facts.  This  is  still  more  true  of  the  outlying  industrial 
regions  of  South  America,  Asia,  Africa.  A  rise  in  prices  in  Eng- 
land or  the  United  States,  due  perhaps  to  one  of  the  periodic 
bursts  of  business  activity  and  banking  expansion,  affects  trade 
with  the  rest  of  the  world.  It  stimulates  imports,  and  tends  to 
a  drain  of  specie.  The  same  sort  of  upward  movement  may  in- 
deed show  itself  elsewhere ;  these  oscillations  have  often  an  in- 
ternational sweep ;  but  none  the  less  a  call  for  specie  is  likely 
to  come  from  countries  whose  credit  machinery  is  less  highly 
developed.  Hence  a  drain  of  specie  to  other  countries  will 
occur  sooner  or  later  as  a  check  on  the  upward  movement  of 
prices  in  those  countries  whose  credit  machinery  contains  the 
greatest  possibilities  of  rapid  expansion. 

This  cause  acts  slowly.  Moreover,  it  seems  to  operate  fitfully, 
because  the  currents  of  international  trade  are  affected  by 
other  causes  also,  among  which  this  fundamental  one  is  often 
concealed.  Yet  none  the  less  it  is  fundamental.  Prices  cannot 


THE  THEORY  OF  PRICES  ONCE  MORE  441 

rise  in  one  country  alone ;  sooner  or  later  all  countries  must  share 
in  the  advance.  In  most  countries  of  the  world,  prices  cannot 
rise  without  a  real  increase  in  "money."  Hence  they  cannot 
rise  for  any  considerable  time  or  to  any  great  extent,  in  the  credit- 
using  countries,  unless  in  all  other  countries  a  parallel  advance 
takes  place,  resting  on  more  copious  money. 

§  8.  By  way  of  illustrating  the  principles  just  stated,  let  us 
consider  the  conditions  under  which  a  world-wide  advance  can 
take  place ;  in  other  words,  consider  the  mode  in  which  a  marked 
increase  of  specie  will  affect  prices.  Suppose  a  greatly  enlarged 
production  at  the  mines,  such  as  has  taken  place  during  the  last 
decade  or  two:  through  what  mechanism  will  prices  be  in- 
fluenced ? 

The  gold  from  the  mines  goes  first  to  the  mints  of  the  mining 
countries  or  of  the  countries  with  which  they  have  closest  connec- 
tion. The  gold  output  of  the  United  States  goes  to  the  American 
mints  for  coinage  into  eagles  and  the  like ;  that  of  Australia  to 
the  Australian  mints ;  and  that  of  South  Africa  chiefly  tp  Eng- 
land. In  these  countries  the  gold,  after  being  coined,  finds  its 
way  first  into  the  vaults  of  banks,  either  directly  as  coin,  or  in 
the  form  of  gold  certificates  or  Bank  of  England  notes.1  If  this 
happens  in  a  period  of  dull  trade,  it  simply  swells  bank  reserves, 
and  tends  to  lower  even  more  the  market  rate  of  discount.  It  is 
very  likely  to  lead  to  a  prompt  overflow  of  the  gold  to  other  coun- 
tries, and  especially  to  the  continent  of  Europe,  before  the  gold 
can  have  had  any  influences  whatever  on  prices  or  general  ac- 
tivity. As  will  appear  more  fully  hereafter,  the  money  and 
banking  markets  of  the  leading  countries  are  in  close  connection, 
and  a  flow  of  specie  from  one  to  another  takes  place  under 
slight  inducement.  None  the  less,  an  effect  on  credit  ex- 
tension and  on  prices  is  likely  to  appear  first  in  the  countries  to 
which  the  gold  first  goes.  It  is  most  likely  to  appear  in  them 
when,  for  some  inscrutable  reason,  the  spirit  of  commercial 
adventure  has  begun  to  be  stirred.  If  the  gold  happens  to  come 

1  In  the  United  States  this  may  take  place  even  without  coinage ;  for  gold 
certificates  are  issued  against  the  deposit  of  gold  in  ban. 


442       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

in  when  that  spirit  has  already  been  aroused ;  or  if,  after  activity 
has  begun,  still  further  supplies  come  in,  —  then  all  the  elements 
of  rapid  expansion  are  present.  Then  other  countries  will  be 
affected  sooner  or  later.  Some  part  of  the  specie  will  overflow 
to  them,  and  an  expansion  take  place  in  them  also,  more  or  less 
rapid  according  as  their  monetary  and  credit  machinery  is  re- 
sponsive. If  new  supplies  of  gold  are  constantly  coming  in  from 
the  mines,  the  steady  outflow  from  the  mining  countries  and 
their  immediate  connections  is  made  good  by  the  fresh  additions, 
and  there  is  no  direct  obstacle  to  the  maintenance  of  the  en- 
larged superstructure  of  credit.  This  superstructure  will  con- 
tinue to  enlarge,  under  the  stimulus  of  pervading  optimism,  until 
at  last  it  becomes  top-heavy.  More  is  built  up  on  the  basis  of 
the  specie,  enlarged  though  it  be,  than  can  long  be  sustained.  Re- 
serves become  comparatively  slender,  the  rate  of  discount  rises, 
and,  in  the  language  of  the  financial  markets,  money  becomes 
scarce  and  dear.  A  commercial  crisis  is  apt  to  ensue ;  then  a 
period  of  dullness  and  superabundant  reserves ;  eventually  a  new 
start  and  the  repetition  of  the  old  round.  As  the  years  go  on  a 
general  though  irregular  advance  in  prices  comes  about ;  more 
rapid  in  times  of  expansion,  checked  in  times  of  depression ;  earlier 
in  some  countries  than  in  others ;  affecting  different  commodi- 
ties to  a  greater  or  less  degree,  according  to  seasonal  conditions, 
adjustability  of  production,  variations  in  utility  and  demand,  — 
yet  on  the  whole  unmistakable  if  the  observations  extend  over 
some  time  and  cover  a  wide  range  of  countries  and  commodities. 

Something  like  this  happened  in  the  decade  following  the 
Californian  and  Australian  gold  discoveries  of  1850;  some- 
thing like  this  happened  again  during  the  ten  or  fifteen  years 
after  1895.  In  the  long  run  an  increase  in  the  supply  of  specie 
or  gold,  greater  than  in  proportion  to  the  increased  supply  of 
commodities,  works  out  its  effects  on  general  prices. 

§  9.  Among  schemes  for  monetary  reform  which  have  been 
proposed  is  one  for  an  automatic  injection  and  withdrawal  of 
money  according  as  prices  fall  or  rise.  For  example,  it  has  been 
proposed  that  government  paper  shall  be  injected  into  circula- 


THE  THEORY   OF  PRICES  ONCE  MORE  443 

tion  on  the  basis  of  officially  constructed  index  numbers.  When 
these  index  numbers  indicate  that  prices  are  falling,  let  more 
money  be  put  forth;  when  rising,  let  some  money  be  retired. 
The  process  of  impounding  an  excess  might  take  place  by  hoard- 
ing ordinary  receipts  for  public  dues,  or  by  selling  securities  on 
terms  which  would  attract  investors. 

All  proposals  of  this  sort  rest  on  the  naive  form  of  the  quantity 
theory.  They  assume  that  prices  respond  promptly  and  in 
precise  proportion  to  changes  in  the  quantity  of  specie  or  of 
money  equivalent  in  its  mode  of  action  to  specie.  The  truth  is 
that  in  our  complex  modern  communities  the  connection  be- 
tween prices  and  the  quantity  of  money  is  not  a  close  one  or  one 
as  to  which  prediction  is  easy.  An  increase  in  specie  may  go  for 
some  time  with  falling  prices,  a  diminution  with  rising  prices. 
An  injection  of  additional  money  by  government  fiat  might 
very  easily  have  at  one  time  no  effect  whatever  in  stemming 
falling  prices,  and  at  another  time  might  plague  its  inventors  with 
vastly  greater  consequences  of  inflation  than  they  had  foreseen. 
This  holds  good  equally  of  specie  and  of  inconvertible  govern- 
ment paper. 

The  monetary  situation  in  which  the  world  now  finds  itself 
is  far  from  an  ideal  one.  Prices  are  affected  in  a  seemingly  cha- 
otic way ;  not  only  by  the  variations  in  the  supply  of  specie,  in  the 
volume  of  commodities,  in  the  ways  and  habits  of  people  in  using 
money  and  dealing  with  goods;  not  only  by  the  more  or  less 
spasmodic  legislation  of  the  several  countries,  —  but  by  the  ups 
and  downs  of  credit  operations  which  obey  no  law  but  that  of 
inconstancy.  Yet  it  is  difficult  to  see  how  any  far-reaching 
change  can  be  made,  short  of  a  complete  revolution  of  industry. 
The  abolition  of  private  property  and  the  adoption  of  some  form 
of  socialism  or  collectivism  would  indeed  bring  an  entirely  differ- 
ent mode  of  carrying  on  the'  division  of  labor  and  the  exchange  of 
commodities.  But  as  long  as  mankind  maintain,  rightly  or 
wrongly,  the  institution  of  private  property,  with  its  essential 
corollaries  of  production  and  investment,  and  sale  and  exchange, 
so  long  some  degree  of  monetary  fluctuation  seems  unavoid- 


444       MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

able.  Nor  does  it  seem  possible  to  find  a  better  basis  for  the  cir- 
culating medium  than  solid  specie, — in  our  own  time,  none 
better  than  gold.  The  best  check  to  the  irregular  fluctuations 
in  the  uses  of  credit  devices  is  that  they  shall  rest  securely  on 
specie,  and  that  all  forms  of  them  shall  be  redeemable  without  fail 
in  specie.  So  long  as  this  is  done,  there  will  be  neither  very  wide 
fluctuations  in  the  course  of  any  one  generation,  nor  very  abrupt 
fluctuations  at  any  time.  For  the  rest,  the  drawbacks  to  the 
present  situation,  serious  as  they  are,  must  be  accepted  as  part  of 
the  price  to  be  paid  for  the  general  gains  from  private  property 
and  free  enterprise. 

§  10.  One  last  topic  may  be  touched  briefly:  what  is 
"money"  ?  The  reader  will  have  noticed  that  in  some  previous 
passages  this  word  has  been  used  in  quotation  marks,  indicating 
that  the  sense  attaching  to  it  is  not  certain.  What  does  the 
word  usually  mean,  and  in  what  sense  is  it  best  used  ? 

"Money"  usually  means  whatever  passes  readily  from  hand 
to  hand  in  settlement  of  transactions.  It  includes  specie,  of 
course ;  not  only  full-value  specie,  but  overvalued  specie  and 
subsidiary  coin.  It  includes  bank  notes  and  government  notes 
convertible  into  specie.  It  includes  paper,  even  though  not  con- 
vertible, so  long  as  this  in  fact  passes  freely.  The  term  thus 
does  not  cover  all  of  that  total  purchasing  power  in  terms  of 
money  which,  as  we  have  seen,  is  the  proximate  force  in  making 
prices.  It  does  not  include  the  great  item  of  deposits.  It 
therefore  describes  only  a  part  of  the  circulating  medium. 

Suggestions  have  been  made  for  the  use  of  a  word  or  phrase 
which  should  connote  the  whole  medium  of  exchange.  It  has 
been  proposed  that  "money"  itself  should  be  used  in  this  wider 
sense.  The  term  "currency"  has  been  used  to  include  every- 
thing that  passes  in  effecting  transactions,  —  so  including  de- 
posits in  their  active  stage  of  the  check.  But  proposals  for 
deliberate  changes  in  economic  terminology  have  never  borne 
much  fruit.  The  writers  who  have  advanced  them  have  not  al- 
ways acted  consistently  in  accord  with  their  own  advice,  reverting 
unconsciously  to  the  use  of  the  familiar  words  in  the  familiar 


THE  THEORY  OF  PRICES  ONCE  MORE  445 

senses;  still  less  has  there  been  any  general  consensus  toward 
a  change.  Hence  the  term  "  money  "  is  most  conveniently  used 
in  the  accepted  popular  sense.  Sometimes  what  is  laid  down  in 
regard  to  money  will  hold  good  of  all  the  circulating  medium, 
the  context  indicating  sufficiently  the  range  of  application  of  the 
word.  Sometimes  it  will  mean  "cash"  only,  in  the  stricter 
sense.  Where  it  is  of  importance  to  discriminate,  use  may  be 
made  of  the  phrases  "circulating  medium"  or  "machinery  of 
exchange,"  cumbrous  though  they  are. 

REFERENCES  ON  BOOK  III 

On  money,  K.  Helfferich,  Das  Geld  (2d  ed.,  1910),  is  an  excellent 
descriptive  and  analytical  book.  On  the  theory  of  money  and  prices, 
I.  Fisher,  The  Purchasing  Power  of  Money  (2d  ed.,  1913),  is  admirable, 
at  once  conservative  and  constructive.  An  entirely  different  mode  of 
reasoning,  and  different  conclusions,  which  I  find  myself  unable  to 
accept,  are  in  J.  L.  Laughlin,  The  Principles  of  Money  (1903).  Views 
similar  to  Laughlin's  are  in  J.  A.  Hobson,  Gold,  Prices  and  Wages  (1913). 
J.  F.  Johnson,  Money  and  Currency  (new  ed.,  1914),  has  convenient 
accounts  of  the  monetary  history  of  various  countries. 

On  banking,  W.  Bagehot,  Lombard  Street  (1873),  is  a  classic,  still  to 
be  read  on  banking  policy,  notwithstanding  the  great  changes  since  its 
date.  C.  F.  Dunbar,  Chapters  on  the  Theory  and  History  of  Banking 
(ed.  by  0.  M.  W.  Sprague,  1900),  is  another  classic,  and  contains  also 
abundant  references.  H.  Withers,  The  Meaning  of  Money,  gives  a 
lucid  and  interesting  account  of  banking  conditions  in  Great  Britain. 
C.  A.  Conant,  A  History  of  Modern  Banks  of  Issue,  is  useful  for  its 
descriptive  matter.  A  vast  mass  of  information  on  the  banking  prob- 
lems and  experiences  of  recent  years  is  in  the  Publications  of  the  Na- 
tional Monetary  Commission  (1909-1911).  i 

On  the  questions  of  principle  underlying  bimetallism,  see  L.  Darwin, 
Bimetallism  (1898).  The  same  questions  are  considered  in  Helfferich, 
Das  Geld  (1910),  already  referred  to.  On  the  dislocations  of  inter- 
national trade  due  to  the  use  of  different  monetary  standards,  see  D. 
Barbour,  The  Standard  of  Value  (1912) ;  with  which  may  be  compared 
J.  M.  Keynes,  Indian  Currency  and  Finance  (1913),  an  able  book, 
touching  on  wider  questions  than  its  title  indicates.  Consult  also 
J.  L.  Laughlin,  History  of  Bimetallism  in  the  United  States;  H.  P. 
Willis,  A  History  of  the  Latin  Monetary  Union  (1901) ;  A.  P.  Andrew, 
"The  End  of  the  Mexican  Dollar,"  in  Quarterly  Journal  of  Economics, 
Vol.  XVIII  (May,  1904) ;  E.  W.  Kemmerer,  "The  Recent  Rise  in  the 
Price  of  Silver  and  Some  of  its  Monetary  Consequences,"  ibid.,  Vol. 
XXVI  (Feb.,  1912). 


446  MONEY  AND  THE  MECHANISM  OF  EXCHANGE 

On  index  numbers  and  methods  of  measuring  prices,  W.  S.  Jevons, 
Investigations  in  Currency  and  Finance  (1884),  though  of  older  date,  is 
still  to  be  read.  See  also  Professor  F.  Y.  Edgeworth's  brilliant  memo- 
randum in  Report  of  the  British  Association  for  the  Advancement  of  Science, 
1887,  pp.  247-303;  and  C.  M.  Walsh,  The  Measurement  of  General 
Exchange  Value  (1901).  An  excellent  discussion  is  in  I.  Fisher,  The 
Purchasing  Power  of  Money,  oh.  X,  and  in  the  same  book  are  abundant 
references  to  the  literature  on  rising  and  falling  prices. 

Good  historical  books  on  crises  are :  C.  Juglar;  Des  crises  commer-- 
dales  et  de  leur  retour  periodique  en  France,  en  Angleterre,  et  aux  Etats- 
Unis  (2d  ed.,  1889),  and  O.  M.  W.  Sprague,  A  History  of  Crises  under 
the  National  Banking  System  (1910) ,  published  by  the  National  Monetary 
Commission.  A  thorough  and  careful  analysis  of  the  phenomena  of 
1890-1910  is  in  W.  C.  Mitchell,  Business  Cycles  (1913) ;  a  book  whose 
method  of  investigation  marks  an  epoch  in  the  study  of  crises.  Also 
notable,  and  more  venturesome  in  attempting  theoretical  generaliza- 
tions, is  A.  Aftalion,  Les  crises  periodiques  de  surproduction  (1913). 


BOOK  IY 

INTERNATIONAL  TRADE 


CHAPTER  32 

THE  FOREIGN  EXCHANGES 

§  1.  The  mechanism  of  international  trade  is  not  essentially 
different  from  that  of  domestic  trade.  It  is  part  of  the  ordinary 
machinery  of  exchange ;  and  it  is  closely  connected  with  the 
banking  operations  and  monetary  phenomena  of  the  several 
countries.  Indeed,  the  whole  theory  of  international  trade  pre- 
sents no  fundamental  peculiarities :  it  is  but  a  phase  of  the  gen- 
eral theory  of  exchange  value.  But  it  has  been  so  much  debated, 
is  so  beset  by  political  and  national  prejudice,  and  is  so  pecul- 
iarly tinged  by  error  in  popular  discussion,  that  there  is  advan- 
tage from  treating  it  separately. 

International  trade,  like  virtually  all  the  trade  of  modern 
countries,  is  carried  on  in  terms  of  money,  and  through  sales  for 
money  by  individuals.  Like  all  other  trade,  it  brings  in  the  end 
the  same  result  as  barter  —  the  exchange  of  goods  or  services  for 
other  goods  or  services.  But  proximately  it  means  sales  for 
money.  We  may  advantageously  begin  our  consideration  of  it 
by  taking  up  first  the  money  mechanism  through  which  it  is 
carried  out. 

When  a  merchant  sells  goods  to  a  person  in  the  same  country, 
the  mode  of  payment  is  simple :  he  receives  the  money  of  his 
own  country.  But  when  he  sells  to  one  in  another  country,  it  is 
not  so  simple.  Transactions  in  England  are  settled  in  pounds, 
shillings  and  pence ;  those  in  the  United  States  in  dollars  and 
cents.  The  American  who  sells  in  England  may  sell  there  in 
terms  of  English  money;  he  must  then  convert  the  English 
pounds  into  American  dollars  before  they  are  available  for  him. 
Or,  if  he  sells  in  England  in  terms  of  American  money,  he  puts 
the  English  purchaser  under  the  obligation  of  converting  into 
dollars  the  pounds  which  alone  are  current  in  England. 
2o  449 


450  INTERNATIONAL  TRADE 

This  process  of  converting  the  money  of  one  country  into  its 
equivalent  in  the  money  of  other  countries  is  carried  out  through 
foreign  bills  of  exchange.  Strictly  speaking,  a  bill  of  exchange  is 
simply  an  order  by  one  person,  addressed  to  another,  directing  a 
payment  to  be  made  to  a  third  person.  It  thus  has  three  parties  : 
the  maker  or  drawer,  drawee  or  acceptor,  and  the  payee.  When 
made  out  in  the  precise  form  settled  by  the  law,  it  fixes  a  guaran- 
tee on  the  maker  to  pay  the  stated  sum,  in  case  the  drawee  does 
not  do  so ;  and,  when  accepted  by  the  drawee  (he  thus  becoming 
the  "acceptor")  it  fixes  unconditional  obligation  upon  him  to 
pay  it  when  due.  Bills  of  exchange  are  freely  used  in  domestic 
transactions,  and  are  then  known  as  inland  bills.  A  check  is  but 
a  kind  of  inland  bill  of  exchange,  drawn  by  a  depositor  on  a  bank 
in  favor  of  a  third  person.  Foreign  bills  of  exchange  have  no 
legal  peculiarities.  Their  economic  peculiarities  (not  such  as  to 
involve  any  essential  differences)  arise  only  from  the  differences 
in  the  currency  systems  of  the  various  countries.  In  the  follow- 
ing pages,  when  bills  of  exchange  are  spoken  of,  foreign  bills  will 
be  meant.  The  mechanism  of  payment  in  foreign  trade  through 
such  bills  is  usually  called  "the  foreign  exchanges,"  —  a  term 
which  might  as  appropriately  be  used  to  describe  exchange  be- 
tween different  countries  in  all  its  phases,  but  is  limited  by  cus- 
tom to  the  dealings  in  foreign  bills. 

For  simplicity  in  exposition,  let  us  suppose  that  the  only  trans- 
actions leading  to  the  use  of  bills  of  exchange  are  those  by  which 
goods  are  sold.  We  shall  see  presently  that  there  are  other 
transactions  of  no  small  importance,  but  the  main  principles  are 
most  easily  explained  in  connection  with  merchandise  trans- 
actions. 

A  merchant  in  New  York  who  sells  goods  to  a  merchant  in 
London  has  a  claim  to  receive  money  from  the  latter ;  he  can 
draw  on  the  Englishman  for  the  price.  He  can  draw  directly 
or  he  can  transfer  his  right.  That  is,  an  exporter  has  bills  of 
exchange  for  sale.  On  the  other  hand,  a  merchant  in  New  York 
who  has  bought  goods  from  a  merchant  in  London  has  an  obliga- 
tion to  pay  money  to  this  Englishman ;  he  must  remit  in 


THE  FOREIGN  EXCHANGES  451 

some  way  the  price.  That  is,  an  importer  needs  to  buy  bills  of 
exchange.  We  are  supposing  here,  again  for  simplicity,  that 
both  transactions  are  carried  on  in  New  York ;  the  exporter  sells 
his  bill  on  London  in  New  York,  the  importer  buys  his  bill  on 
London  in  New  York.  Suppose  now  that  the  two  obligations 
are  for  the  same  amount,  say  £1000.  The  importer  can  buy  from 
the  exporter  the  latter's  bill,  drawn  on  his  London  debtor  for 
that  amount.  The  importer  sends  the  bill  to  his  London  cred- 
itor ;  the  latter  collects  the  sum  from  the  London  debtor.  The 
New  York  creditor  gets  his  money  from  the  New  York  debtor, 
and  the  London  creditor  gets  his  money  from  the  London  debtor. 
By  one  payment  in  New  York  and  another  in  London,  the  trans- 
actions are  liquidated  without  any  sending  of  specie  from  one 
country  to  the  other.  Through  the  mechanism  of  the  bill  of  ex- 
change, the  exports  serve  to  pay  for  the  imports. 

§  2.  What  amount,  now,  would  the  New  York  importer  pay, 
in  American  money,  to  the  New  York  exporter?  One  thou- 
sand British  sovereigns  contain  as  much  pure  gold  as  $4866. 
Hence,  when  a  bill  for  £1000  sells  for  $4866,  its  precise  specie 
equivalent,  exchange  is  said  to  be  at  par.  If  the  American 
creditor  sent  to  England  for  his  money,  brought  the  gold  from 
London  to  the  United  States,  and  had  it  coined  into  American 
dollars,  he  would  get  from  the  mint  this  exact  number  of  dollars, 


Suppose,  now,  a  number  of  exporters  and  importers  in  both 
countries,  and  a  large  volume  of  dealings :  the  case  remains 
the  same.  The  exporters  sell  bills,  the  importers  buy  them. 
If  the  money  value  of  the  imports  just  equals  the  money  value 
of  the  exports,  the  bills  of  exchange  exactly  liquidate  the  trans- 
actions. •  Under  such  circumstances,  exchange  will  be  at  par. 
Foreign  trade  will  be  in  a  state  of  equilibrium,  the  exports  will 
just  pay  for  the  imports,  and  no  specie  will  flow  from  one  coun- 
try to  the  other. 

Suppose,  next,  that  for  some  reason  the  exports  from  the 
United  States  exceed  the  imports  in  money  value.  The  two 
sets  of  transactions  —  the  buying  'of  goods  from  persons  in 


452  INTERNATIONAL  TRADE 

England,  and  the  selling  of  goods  to  persons  in  that  country 
—  are  quite  independent.  The  American  exporters  may  sell 
goods  to  a  greater  money  value  than  that  of  the  goods  which 
the  importers  have  to  pay  for.  They  will  then  offer  bills  for  a 
greater  amount  than  the  importers  have  occasion  to  buy. 
Under  these  circumstances  all  the  bills  cannot  be  sold  to  im- 
porters. Some  will  necessarily  be  left  over.  The  exporters 
who  have  the  excess  on  their  hands  can  do  nothing  but  send 
to  England  for  the  specie.  This,  however,  involves  expense. 
The  specie  must  be  checked  with  care,  must  be  boxed,  insured, 
transported  by  land  and  water.  When  it  reaches  the  Ameri- 
can creditor,  it  must  be  carried  to  the  mint  and  coined  into 
American  dollars,  —  a  process  which  may  take  some  time.  There 
is  the  possibility  that  some  of  the  sovereigns  may  not  be  quite 
full  weight,  even  though  not  below  the  limit  of  tolerance  in  Eng- 
land. Not  least,  there  is  a  loss  of  interest  during  the  period 
which  elapses  before  the  cash  is  available  in  the  United  States. 
All  these  circumstances  make  the  American  exporter  willing  to 
sell  a  bill  for  £1000  for  a  less  sum  than  par,  —  less  than  $4866. 
The  amount  of  reduction  to  which  he  will  submit,  will  be  only 
such  as  offsets  the  total  expense  of  sending  to  England  for  the 
specie.  That  expense  is  surprisingly  small,  —  between  Eng- 
land and  the  United  States,  somewhere  about  one  half  of  one 
per  cent.  The  bill  of  exchange  for  £1000  will  not  sell  for  less 
than  $4845,  or  $4.845  to  the  pound.  This  is  called  the  specie- 
importing  point.  When  foreign  exchange  is  at  this  point, 
specie  begins  to  come  in. 

Under  these  conditions,  all  of  the  exporters'  bills  will  be  at 
a  discount :  all  will  sell  for  less  than  their  par  value.  Com- 
petition being  active  between  the  exporters,  no  one  of  them 
will  be  willing  to  sell  his  bill  for  a  less  price  than  the  others. 
The  expense  of  shipping  specie  will  have  to  be  met  by  some 
one  or  other  among  them ;  to  each  one  it  is  immaterial  whether 
he  will  sell  his  bill  at  a  discount  or  will  send  for  specie.  The 
market  rate  for  all  bills,  when  there  is  a  clear  excess  of  exports, 
will  be  at  the  specie-importing  point. 


THE  FOREIGN  EXCHANGES  453 

The  reverse  situation  appears  when  the  imports  exceed  the 
exports.  The  importers  then  need  to  buy  more  bills  than  the 
exporters  can  supply.  Some  of  them  will  have  to  send  out 
specie,  and  this  involves  the  same  sort  of  expense  as  bringing 
specie  in.  An  importer  who  has  to  remit  to  London  can  afford 
to  pay  more  than  $4866  for  a  bill  of  £1000,  rather  than  send 
specie.  He  will  pay  as  much,  say,  as  $4885.  If  called  on  to 
pay  more  than  $4885,  he  will  refuse ;  for  he  can  ship  $4866  to 
England,  and  have  this  coin  there  converted  into  sovereigns.1 
Foreign  exchange  in  New  York  will  be  at  a  premium,  the  extent 
of  that  premium  being  limited  by  all  the  expenses  involved  in 
transporting  specie.  The  specie-exporting  point,  determined 
by  these  expenses,  is  about  $4.885.  When  there  is  a  clear  excess 
of  imports  over  exports,  exchange  will  be  at  this  premium; 
and,  in  like  manner  as  in  the  other  case,  all  the  importers  will 
have  to  pay  this  premium,  although  most  of  the  transactions 
are  liquidated  through  bills. 

§  3.  These  are  the  simplest  supposable  conditions.  They 
are  rarely  met  in  real  life.  Here,  as  in  almost  all  the  buying 
and  selling  of  modern  communities,  a  class  of  middlemen  inter- 
venes. The  exporters  and  importers  do  not  deal  directly  with 
each  other;  neither  do  they  concern  themselves  with  the  pos- 
sibilities of  shipping  specie  in  or  out.  They  go  to  the  dealers 
in  foreign  exchange.  These  are  sometimes  firms  which  make  a 
specialty  of  this  sort  of  business,  the  so-called  foreign-exchange 
houses;  sometimes  they  are  banking  firms  which  join  it  with 
other  business.  All  these  middlemen  buy  exchange  constantly 
from  the  exporters,  and  sell  it  constantly  to  the  importers. 
They  have  their  well-known  correspondents  in  foreign  coun- 
tries, either  branch  houses  of  their  own,  or  other  banking  firms ; 
they  sell  bills  on  these,  and  meet  bills  drawn  by  these.  When 
the  exporters  offer  more  bills  than  the  importers  will  piesum- 

1  Foreign  coin,  or  bullion,  when  it  reaches  England,  is  always  taken  to  the  Issue 
Department  of  the  Bank  of  England,  which  is  obliged  by  law  to  give  notes  for 
gold  at  a  fixed  rate,  involving  a  very  slight  charge  to  the  holder  of  the  gold.  The 
Bank  of  England  thus  acts  as  intermediary  for  the  conversion  of  bullion  and 
foreign  coin  into  English  money. 


454  INTERNATIONAL  TRADE 

ably  take,  the  dealers  none  the  less  buy  them ;  only,  calculat- 
ing that  there  will  be  no  market  for  all  the  bills,  and  that  some 
will  have  to  be  sent  abroad  and  specie  got  with  them,  they  will 
buy  only  at  a  discount.  On  the  other  hand,  when  the  im- 
porters demand  more  bills  than  the  exporters  have  to  offer, 
the  dealers  sell  to  the  importers,  at  a  premium,  whatever  bills 
the  latter  want,  and  themselves  send  abroad  the  specie  with 
which  to  meet  these  bills  when  presented.  Being  in  the  busi- 
ness and  equipped  for  it,  they  can  ship  specie  more  economi- 
cally than  the  importers  or  exporters.  Though  they  make  a 
profit,  it  is  based  on  a  very  narrow  margin. 

With  the  presence  of  dealers  comes  that  process  of  close 
bargaining,  speculation,  equalization,  which  naturally  ensues 
with  the  specialization  of  trade.  From  the  description  just 
given  of  the  simple  case,  —  that  of  exporters  selling  directly  to 
importers,  —  it  might  be  inferred  that  if  there  was  any  discount 
at  all  or  any  premium  at  all,  it  would  be  up  to  the  full  limit 
set  by  the  expense  of  shipping  specie.  But  with  the  higgling 
and  speculation  among  dealers,  a  discount  or  premium  will 
appear  which  may  be  much  within  these  limits.  If,  for  example, 
more  bills  are  offered  by  exporters  at  a  given  time  than  the 
importers  are  buying,  the  dealers  may  yet  anticipate  with 
confidence  that  before  long  a  turn  will  come  the  other  way, 
and  that  at  the  later  time  the  importers'  demands  will  be  in 
excess.  They  will  buy  the  exporters'  bills,  and  wait  for  the 
turn.  Possibly  they  will  hold  the  bills  in  their  own  hands  for 
a  while ;  possibly  they  will  send  the  bills  to  their  foreign  cor- 
respondents, tell  these  to  collect  the  money  from  the  foreign 
debtors,  and  hold  the  amounts  until  drawn  against  later.  The 
current  rates  of  interest  on  demand  loans  and  short-time  loans 
are  important  factors  in  these  operations.  If  "money"  is 
cheap  (the  rate  of  interest  is  low)  in  the  dealer's  own  country, 
he  will  more  readily  buy  exporters'  bills,  and  pay  a  better 
price  for  them.  If  money,  again,  is  dear  in  the  foreign  coun- 
try, he  will  also  buy  such  bills  more  readily,  since  he  can  send 
them  to  the  foreign  country  and  there  get  a  balance  to  his 


THE  FOREIGN  EXCHANGES  455 

credit  on  which  interest  at  a  good  rate  is  allowed.  To  figure 
out  the  price  at  which  it  is  profitable  to  buy  or  sell  exchange, 
calls  for  nice  calculation  of  a  number  of  items  each  involving 
a  very  small  fraction,  —  the  direct  expense  of  transportation, 
the  mint  charges  and  delays,  the  rates  of  interest  in  different 
countries,  the  probabilities  of  shifting  currents  of  trade.  Com- 
petition among  the  dealers  leads  to  a  market  rate  somewhere 
between  the  two  specie  points. 

If,  indeed,  there  is  a  continued  balance  of  payments  to  be 
made  one  way  or  the  other,  —  if  there  is  a  steady  and  consider- 
able excess  of  imports  or  of  exports,  —  then  exchange  goes  to 
the  shipping  point,  and  specie  flows  in  or  out.  The  operations 
of  dealers  may  enable  the  imports  and  exports  to  catch  up  with 
each  other,  and  so  may  postpone  the  shipment  of  specie ;  but 
where  there  is  continuing  excess  one  way  or  the  other,  it  moves 
in  or  out. 

In  the  examples  here  chosen,  we  have  spoken  as  if  all  the 
transactions  in  foreign  exchange  took  place  in  New  York,  — 
as  if  the  London  merchants  were  passive,  and  waited  for  those 
in  New  York  to  buy  and  sell  exchange,  and  remit  bills  to  Lon- 
don in  settlement  of  the  debts.  In  fact  some  of  the  trans- 
actions take  place  in  each  country.  Which  of  the  trading 
persons  shall  take  the  initiative  in  any  particular  case,  depends 
on  the  bargain  between  them.  It  may  be  arranged  that  the 
New  York  exporter  shall  draw  on  his  London  customer,  and 
so  sell  in  New  York  exchange  on  London ;  or  the  London  cus- 
tomer may  assume  an  obligation  to  remit  to  this  New  York 
vendor,  and  so  buy  in  London  exchange  on  New  York.  Both 
sorts  of  transactions  are  going  on  all  the  time,  and  in  both  centers 
exchange  between  London  and  New  York  is  constantly  being 
dealt  in.  When  in  New  York  English  exchange  is  at  a  premium, 
then  in  London  American  exchange  is  at  a  discount.  All  the 
transactions  are  under  the  watchful  eyes  of  the  dealers;  a 
remarkably  close  equalization  of  rates  is  brought  about ;  while, 
at  the  same  time,  there  is  play  for  profit  and  speculation  hi 
terms  of  a  small  fraction  of  one  per  cent. 


456  INTERNATIONAL  TRADE 

Bankers'  bills,  so-called,  —  the  bills  drawn  by  dealers  and 
bankers  on  their  foreign  correspondents,  —  naturally  sell  for  a 
somewhat  higher  price  than  most  mercantile  or  trade  bills. 
They  contain  the  names  of  persons  and  firms  well-known  in  the 
business  world.  Again,  sight  bills  naturally  sell  for  a  higher 
price  than  time  bills.  Foreign  sales  of  merchandise,  like  domes- 
tic sales,  are  usually  on  time.  The  exporter  who  has  sold 
goods  is  then  entitled  to  receive  his  money  at  the  end  of  thirty 
days,  sixty  days,  or  whatever  the  period  for  which  credit  is 
given.  He  draws  his  bill  payable  after  thirty  or  sixty  days,  and 
discounts  it  at  his  bank.  The  bank,  if  it  deals  in  foreign  ex- 
change itself,  perhaps  holds  the  bill  till  maturity,  perhaps  sends 
it  abroad  at  once  to  its  foreign  correspondent;  or  sells  it  to 
a  dealer  in  foreign  exchange,  at  once  or  on  maturity.  The 
price  at  which  it  will  sell  depends  on  the  length  of  time  it  has 
to  run,  on  the  current  rate  of  discount,  on  the  calculations  of 
the  probable  state  of  foreign  exchange  at  its  maturity.  These 
minutiae,  and  others,  need  not  here  be  entered  on.  They  do 
not  affect  the  broad  questions  of  principle  regarding  money, 
prices,  and  international  trade  with  which  we  are  chiefly  con- 
cerned. 

§  4.  The  rates  of  foreign  exchange  are  determined,  not  by  the 
dealings  between  each  separate  pair  of  countries,  but  by  those 
between  a  country  and  all  the  other  countries  with  which  it 
trades.  The  exports  from  the  United  States  to  England  may 
much  exceed  the  imports  —  in  fact,  they  do  greatly  exceed 
them  every  year ;  but  exchange,  none  the  less,  may  be  at  par, 
if  the  United  States  imports  heavily  from  other  countries. 

This  situation  is  illustrated  by  the  state  of  trade  between 
the  United  States,  England  (i.e.  Great  Britain),  and  Brazil. 
The  United  States  exports  great  quantities  of  cotton  and  food- 
stuffs to  England;  much  greater  in  value  than  the  manufac- 
tures which  it  imports  from  England.  England  exports  manu- 
factures to  Brazil,  greater  in  value  than  her  imports  from  that 
country.  Brazil,  again,  exports  largely  to  the  United  States 
(chiefly  coffee),  but  imports  thence  comparatively  little.  A 


THE  FOREIGN  EXCHANGES  457 

merchant  in  New  York  who  has  bought  coffee  from  one  in 
Brazil  could  not  easily  find  an  American  exporter  who  had  bills 
of  exchange  on  Rio  Janeiro  or  Bahia  to  sell.  But  he  could 
find  plenty  of  exporters  who  had  sold  grain  and  cotton  in 
England,  and  had  bills  on  London  and  Liverpool  to  sell.  He 
buys  English  exchange  and  with  this  pays  his  debt  in  Brazil. 
Bills  on  London  are  welcome  to  the  Brazilians,  since  in  that 
country  there  are  payments  to  be  made  for  purchases  of  Eng- 
lish goods.  All  these  exchange  transactions,  of  course,  do  not 
take  place  directly  between  exporters  and  importers,  but 
through  the  bankers,  who  buy  and  sell  the  bills,  and  take  keen 
advantage  of  every  opportunity  for  equalizing  payments  with- 
out the  shipment  of  specie.  Thus  by  the  mechanism  of  bills 
of  exchange,  the  exports  of  grain  from  the  United  States  to 
England  serve  to  pay  for  the  imports  of  coffee  from  Brazil  to 
the  United  States ;  and  these  same  shipments  of  coffee,  viewed 
as  exports  from  Brazil,  serve  to  pay  for  Brazil's  imports  of 
manufactures  from  England. 

Sterling  exchange  bills,  drawn  on  London,  are  the  most 
widely  used  in  international  transactions,  and  especially  in 
settling  cross  payments  between  different  countries.  Great 
Britain's  enormous  international  trade  ramifies  into  all  parts 
of  the  world.  Many  English  banks  and  firms  have  well-estab- 
lished repute  as  dealers  in  foreign  exchange.  For  a  century  or 
two  England  has  had  great  industrial  prestige ;  and  the  pound 
sterling  is  the  best-known  unit  of  value  for  the  whole  trading 
world.  Hence  foreign-exchange  transactions  are  apt  to  be 
settled  through  London,  and  by  bills  drawn  on  London.  These 
are  freely  used  by  foreign-exchange  houses  in  settlements  among 
themselves,  and  enable  them  to  supply  bills  for  the  payments 
which  their  customers  need  to  make,  —  either  bills  on,  say, 
Brazil  itself,  or  bills  on  London  which  are  freely  usable  in 
Brazil. 

The  total  exports  of  a  country  are  thus  to  be  balanced  by 
its  total  imports,  and  the  state  of  the  foreign  exchanges  depends 
on  the  whole  of  its  international  trade.  England  exports  manu- 


458  INTERNATIONAL  TRADE 

factured  goods  to  all  parts  of  the  world,  and  with  these  pays 
for  her  imports  of  foodstuffs  and  raw  materials,  of  which  she 
procures  a  large  part  from  the  United  States.  The  United 
States,  again,  buys  tea,  coffee,  cocoa,  spices,  sugar,  and  the 
like,  from  tropical  and  semi-tropical  countries,  and  mainly 
pays  for  them,  not  by  direct  exports  to  these  countries,  but  by 
exports  of  grain,  meat  products,  and  cotton,  to  England  and 
other  European  countries.  If  there  is  a  general  excess  of  im- 
ports over  exports,  foreign  exchange  is  at  a  premium,  and  specie 
tends  to  flow  out;  while  a  general  excess  of  exports  brings 
exchange  to  a  discount,  and  causes  an  inflow  of  specie. 

§  5.  Suppose,  now,  that  the  total  exports  do  not  suffice  to 
pay  for  the  total  imports.  Then  they  must  be  paid  for  in 
specie.  Will  that  specie  flow  out  for  an  indefinite  time?  and 
what  likelihood  is  there  that  a  balance  will  permanently  remain 
to  be  paid  in  this  way  ? 

The  accepted  answer  to  these  questions,  and  in  essentials 
the  accurate  one,  is  that  the  flow  of  specie  sets  in  motion  forces 
which  sooner  or  later  stop  the  flow.  When  specie  leaves  a 
country,  prices  tend  to  fall.  Hence  that  country  becomes  one 
in  which  it  is  advantageous  to  buy.  Lower  prices  stimulate 
exports.  Conversely,  the  country  to  which  specie  flows  tends 
to  have  rising  prices.  It  becomes  one  in  which  it  is  advan- 
tageous to  sell.  Higher  prices  stimulate  imports.  Hence  the 
flow  of  specie  has  an  automatic  limitation.  The  greater  it  is, 
the  more  certain  is  it  likely  to  cease;  the  longer  it  has  gone 
on,  the  sooner  is  it  likely  to  cease.  Merchandise  exports  and 
imports  on  the  whole  and  in  the  long  run  balance,  in  conse- 
quence of  the  effect  of  the  quantity  of  money  on  prices. 

This  is  the  answer  in  its  simplest  form ;  it  is  the  statement 
of  the  fundamental  principle.  But,  like  other  economic  prin- 
ciples, it  holds  true  of  the  course  of  industry  only  in  general 
and  in  the  long  run.  In  details,  it  needs  to  be  qualified  and 
explained  in  various  ways. 

The  modern  mechanism  of  banking,  currency,  and  inter- 
national trade  may  be  said  to  have  an  innate  repugnance  to  the 


THE  FOREIGN  EXCHANGES  459 

flow  of  gold  from  country  to  country.  All  sorts  of  devices  are 
resorted  to  in  order  to  prevent  or  lessen  such  a  flow. 

Most  familiar  and  effective  among  these  devices  is  regula- 
tion through  the  rate  of  discount.  Gold,  like  any  other  form 
of  money,  is  free  capital,  or  command  of  capital  goods;  and 
it  is,  moreover,  the  kind  of  capital  which  is  in  every  country 
equally  available.  It  tends  to  go  to  the  place  where  the  return 
on  loanable  funds  is  largest.  When  specie  first  moves  out  of  a 
country,  it  comes  ordinarily  from  the  bank  reserves;  and 
when  it  goes  into  a  country,  it  goes  ordinarily  into  the  bank 
reserves.  The  rate  of  discount  rises  as  bank  holdings  become 
less,  and  falls  as  they  become  greater.  These  changes  of  them- 
selves tend  to  counteract  the  movement  of  specie  in  large 
quantities.  The  great  central  banks  of  England,  Germany, 
France,  Austria,  and  other  countries  systematically  raise  or 
lower  their  rate  of  discount  in  order  to  protect  their  specie 
holdings.  The  same  thing  happens,  though  with  less  direct  and 
conscious  intent,  in  New  York.1 

Often  the  changes  in  the  rate  of  discount  affect  not  so  much 
the  volume  of  the  flow  of  gold,  as  its  date  and  direction.  A  rise 
in  the  rate  brings  an  additional  pressure  to  bear  on  those  foreign- 
exchange  dealers  who  may  be  preparing  for  a  shipment  of  specie. 
Higher  interest  on  money  makes  it  more  profitable  to  keep  the 
money  at  home.  It  tempts  bankers  to  wait  until  perhaps  the 
currents  of  foreign  trade  turn  and  enable  the  demand  for  exchange 

1  The  "protection"  of  specie  holdings  through  the  rate  of  discount  is  often 
referred  to  as  one  of  the  advantages  of  central  banks.  They  are  supposed  to 
control  the  flow  better  than  non-centralized  banks.  The  difference  in  effectiveness 
seems  to  me  not  considerable,  and  the  argument  for  centralization  on  this  score 
of  no  great  weight.  Lurking  underneath  the  argument  there  is  often  a  relic  of 
older  notions  as  to  the  importance  of  retaining  specie  in  a  country,  and  the  harm 
from  losing  specie,  —  a  notion  strengthened  by  the  repugnance  of  the  business 
community  toward  anything  which  tends  to  lower  prices.  In  the  main,  the  flow 
of  specie  takes  care  of  itself,  and  brings  neither  loss  nor  gain  to  a  country. 

Of  course  a  country  whose  currency  ia  top-heavy,  with  a  large  structure  of 
credit  on  a  slender  basis  of  specie,  may  be  much  disturbed  by  a  moderate  outflow 
of  specie.  This  is  likely  to  be  the  case,  above  all,  in  a  country  which  has  had  in- 
convertible paper,  and  has  proceeded  to  resumption  of  specie  payments  without 
having  retired  a  large  part  of  the  paper.  Compare  what  is  said  in  Chapter  23, 
§  4  ;  Chapter  33,  §  5. 


460  INTERNATIONAL  TRADE 

to  be  met  without  the  shipment.  Or  it  may  lead  such  persons 
to  arrange  for  shipment  of  specie  from  some  other  country.  If 
reserves  are  low  and  discount  rates  high  in  England,  and  the 
contrary  is  the  case  in  Germany,  English  bankers  may  buy 
exchange  on  Germany,  and  thereby  secure  the  means  of  shipping 
specie  from  Germany  to  the  United  States.  Very  sharp  calcu- 
lations and  very  minute  fractions  in  rates  (both  in  rates  of  dis- 
count and  rates  of  exchange)  suffice  to  turn  the  currents  one 
way  or  another. 

Still  another  phase  of  international  dealings  affects  an 
incipient  flow  of  specie  and  consequent  changes  in  bank  dis- 
count, —  the  movement  of  securities  from  one  country  to  an- 
other. This  is  part  of  the  general  process  of  lending  and  borrow- 
ing between  nations,  of  which  more  will  be  said  in  the  next 
chapter.  It  suffices  here  to  point  out  that  the  prices  of  secu- 
rities in  any  one  country  are  usually  affected  inversely  to  the 
rate  of  discount,  rising  as  this  falls,  and  falling  as  this  rises. 
Hence  securities  which  have  an  international  market  are  likely 
to  be  sent  in  place  of  specie  in  settling  balances.  There  are 
brokerage  firms  which  make  it  a  business  to  watch  the  fluctua- 
tions of  such  securities  in  the  different  markets,  —  London, 
Berlin,  Paris,  New  York,  —  and  to  buy  in  the  one  and  sell  in 
the  other,  on  very  slight  margins  of  profit ;  and  these  dealings 
are  closely  dependent  on  the  foreign  exchange  market  and  in  turn 
are  of  prompt  effect  on  that  market. 

None  the  less,  all  devices  of  whatever  sort  do  not  prevent  the 
movement  of  gold,  or  its  ultimate  effect  on  prices.  They  serve 
only  to  regulate  and  equalize  it,  —  to  prevent  it  from  taking 
place  in  a  rush  or  from  having  sudden  and  rapidly  disturbing 
effects.  When  there  is  a  long-continued  balance  of  payments  in 
favor  of  a  country,  specie  flows  into  it.  Gold,  in  fact,  is  con- 
stantly moving  from  country  to  country.  Hardly  a  month 
passes  without  some  shipment  of  it  into  or  out  of  each  of  the 
important  countries.  This  is  particularly  the  case  with  England, 
which,  being  the  center  of  dealings  in  foreign  exchange,  is  also 
an  international  distributing  center  for  gold.  Almost  every 


THE  FOREIGN  EXCHANGES  461 

week  gold  is  shipped  into  England  and  out  of  England,  —  the 
result  being  usually  a  very  small  net  change  for  England  her- 
self, but  on  frequent  occasions  a  considerable  diversion  in  the 
flow  to  or  from  some  other  country.  When  there  is  a  balance  of 
payments  to  be  made  to  any  one  country  because  of  a  consider- 
able and  sustained  excess  of  its  exports,  the  current  of  gold 
moves  in  that  direction  from  England  and  perhaps  from  other 
countries  also,  and  keeps  on  moving,  until  gradually  equalization 
is  brought  about  by  changes  in  prices  and  by  a  restored  balance 
between  the  countries. 

Sometimes  this  result  is  reached  without  any  movement  of 
gold  at  all,  or  with  a  movement  that  seems  not  at  all  in  propor- 
tion to  the  result.  A  country  may  be  issuing  paper  money,  or 
increasing  its  bank  notes  or  deposits,  —  operations  which  in 
themselves  tend  to  expel  gold.  Then  what  happens  is  that  the 
country  retains  both  its  paper  and  more  or  less  of  its  gold,  and 
gets  rising  prices  without  any  influx  of  the  metal.  Again,  the 
country  may  be  one  that  mines  gold.  Ordinarily  a  mining  coun- 
try exports  gold  in  the  normal  course  of  its  international  trade ; 
but  when  its  exports  of  other  things  are  heavy,  it  may  retain 
within  its  own  borders  the  gold  which  would  otherwise  go  out. 
The  United  States  is  an  important  gold-mining  country,  yet 
for  several  decades  has  kept  within  her  borders  the  whole 
product  of  her  mines;  indeed,  has  imported  a  substantial 
amount  of  gold  in  addition.  The  supply  of  specie  thus 
gradually  accumulated  has  been  the  result  of  a  constant  excess 
of  exports,  and  has  been  the  basis  of  a  tendency  toward  higher 
prices. 

The  consequence  of  all  these  modifying  factors  is  that  the 
flow  of  gold  from  country  to  country  takes  place,  as  a  rule,  not 
by  large  movements  at  any  one  time,  but  by  driblets  going  some- 
times one  way,  sometimes  another ;  often  by  little-noticed  diver- 
sions of  the  fresh  supplies,  from  mines.  The  comparative 
smallness  of  the  ordinary  flow  is  due  mainly  to  the  fact  that 
international  trade,  long-maintained,  has  already  brought  about 
such  a  distribution  of  the  precious  metals,  and  such  a  range  of 


462  INTERNATIONAL  TRADE 

prices  in  the  several  countries,  that  their  exchanges  balance  very 
closely.  It  is  only  when  great  industrial  changes  occur  that  a 
large  movement  of  specie  takes  place ;  and  even  then  it  is  com- 
monly distributed  over  a  period  of  several  years.  Our  own 
country,  anomalous  in  so  many  of  its  economic  characteristics, 
presents  in  this  matter  also  the  most  marked  exceptions  to  the 
usual  situation.  Not  infrequently  —  as,  for  example,  in  1879- 
1880,  immediately  after  the  resumption  of  specie  payments,  and 
again  in  1896-1897,  after  the  close  of  a  severe  period  of  depres- 
sion— a  great  change  in  the  relations  of  our  imports  and  exports 
has  caused  rapid  and  heavy  inflows  of  gold,  giving  the  founda- 
tion for  a  rapid  and  sharp  rise  in  prices. 

So  insignificant  are  the  ordinary  currents  of  gold  from  one 
country  to  another,  so  likely  to  be  disguised  by  eddies  and  cross 
currents  due  to  the  complexity  of  international  dealings,  that 
some  writers  have  pooh-poohed  the  whole  theory  of  the 
equalization  of  imports  and  exports  by  changes  in  international 
prices.  Yet  without  this  theory  it  is  impossible  to  explain 
the  facts,  and  especially  the  adjustment  of  the  money  value 
of  exports  and  imports.  The  influence  of  the  quantity  of  gold 
on  prices,  slow-moving  as  it  is,  and  subject  to  all  sorts  of  dis- 
turbing causes,  is  the  underlying  persistent  force  which  deter- 
mines not  only  the  international  distribution  of  specie,  but  also, 
as  will  appear  in  the  chapters  that  follow,  the  variations  hi  the 
purchasing  power  of  gold  in  different  countries,  and  the  greater 
or  less  extent  in  which  those  countries  share  the  gains  from 
international  trade. 

§  6.  The  foreign  exchanges  between  most  countries  rest  on 
the  equivalents'  of  different  gold  coins,  —  dollars,  pounds, 
marks,  francs,  and  so  on.  But  not  all  countries  are  on  a  gold 
basis ;  and  where  there  are  monetary  systems  having  different 
foundations,  there  is  obviously  a  complication  in  the  foreign 
exchanges. 

British  India,  for  example,  was,  until  1893,  on  a  silver  basis, 
the  monetary  unit  being  the  silver  rupee.  The  trade  of  India 
was  chiefly  with  Great  Britain,  whose  currency  was  on  a  gold 


THE  FOREIGN  EXCHANGES  463 

basis.  The  British  exporter  who  sold  goods  hi  India  had  a 
bill  of  exchange  to  sell  on  that  country,  —  that  is,  a  bill  pay- 
able in  silver.  The  Indian  exporter  who  sold  goods  in  Eng- 
land had  for  sale  a  bill  of  exchange  payable  in  gold.  The  price 
of  each  bill  of  exchange  was  affected,  of  course,  by  the  ordinary 
fluctuations  in  the  foreign  exchanges,  —  the  relations  of  im- 
ports and  exports  and  the  excess  or  deficiency  of  bills  for  making 
the  payments  required.  But  it  was  affected  no  less  directly 
by  the  gold  price  of  silver;  and  for  many  years  this  was  the 
main  determining  influence.  As  silver  fell  in  price,  the  English 
exporter's  bill  on  India  became  less  valuable  in  England;  it 
was  one  for  which  he  could  get  less  sovereigns.  Under  the 
same  conditions  —  falling  price  of  silver  —  the  Indian  exporter 
had  in  India  a  more  valuable  bill,  one  for  which  he  could  get 
more  rupees.  This  situation  operated  to  stimulate  exports 
from  India  to  Great  Britain,  and  to  check  exports  from  Great 
Britain  to  India.  There  was  something  in  the  nature  of  a 
bounty  on  exports  from  India,  —  one  which  caused  bitter  com- 
plaint among  those  whose  industries  were  affected  by  Indian 
competition. 

This  situation,  instead  of  leading  to  readjustment  with  some 
promptness,  as  it  would  have  done  between  advanced  coun- 
tries, persisted  because  prices  in  India  did  not  accommodate 
themselves  to  the  new  relation  between  gold  and  silver.  Silver 
flowed  into  India,  and  prices  did  rise  in  that  country.  But 
they  rose  very  slowly  in  this  huge  and  sluggish  population  of 
hundreds  of  millions,  with  its  semi-medieval  conditions  and 
great  tenacity  of  custom.  The  large  use  of  silver  in  the  arts, 
especially  for  ornaments,  diverted  much  of  it  from  monetary 
channels.  Moreover,  the  fall  in  the  gold  price  of  silver  went 
on  year  after  year ;  and,  though  prices  of  commodities  in  India 
might  rise  a  bit,  the  continuing  fall  in  the  price  of  silver  still 
served  to  maintain  a  discrepancy  between  prices  of  commodi- 
ties on  the  one  hand,  and  the  market  price  of  silver  and  the 
rates  of  foreign  exchange  on  the  other.  Imports  and  exports 
were  thus  affected  by  an  unusual  set  of  forces,  —  proximately 


464  INTERNATIONAL  TRADE 

by  abnormal  foreign  exchange,  but  really  by  the  slow  process 
of  adjustment  in  India  to  the  new  price  of  silver.1 

§  7.  Similar  disturbing  effects  are  produced  by  inconvertible 
paper  money.  Where  such  money  has  displaced  specie,  and 
where  higher  prices  and  a  premium  on  gold  have  ensued,  there 
are  again  two  sets  of  influences  on  the  foreign  exchanges,  —  the 
ordinary  shifts  in  the  balance  of  payments  due  to  exports  and 
imports,  and  the  depreciation  of  the  paper.  During  the  period 
of  paper  money  in  the  United  States  from  1862  to  1879,  bills 
of  exchange  on  London  sold  in  New  York  at  a  price  determined 
mainly  by  the  price  of  gold  in  our  paper  money.  A  bill  on 
London  was  the  equivalent  of  gold ;  that  is,  of  gold  obtainable 
at  the  maturity  of  the  bill  and  subject  to  delay  until  it  could 
be  brought  over  from  London.  When  exports  were  compara- 
tively heavy,  London  exchange  sold  at  a  premium  less  than 
equivalent  to  the  current  gold  premium;  when  imports  were 
comparatively  heavy,  London  exchange  sold  at  a  premium 
more  than  equivalent.  Of  the  causes  of  fluctuations  in  foreign 
exchange  under  such  conditions,  those  that  root  in  the  domestic 
gold  premium  are  usually  more  important  than  those  that 
affect  the  price  of  exchange  considered  by  itself;  because  the 
limits  of  fluctuation  in  exchange  proper  are  narrow,  while  those 
of  the  specie  premium  are  potentially  wide.  And  at  such  times 
the  price  of  foreign  exchange  is  a  sensitive  indication  of  the 
state  of  the  paper.  A  premium  on  exchange,  greater  than  that 
of  the  gold-shipping  point,  is  usually  the  first  sign  of  deprecia- 
tion. Even  before  a  premium  on  gold  appears  directly,  an 
abnormally  high  price  of  exchange  points  to  a  difficulty  in 
getting  specie  and  to  a  beginning  of  depreciation. 

As  with  silver,  so  with  paper,  a  discordance  between  the 
premium  on  gold  and  the  rise  in  the  general  prices  may 

1  The  government  of  India,  as  has  already  been  noted  (see  Book  III,  Chapter 
21,  §  5),  put  an  end  to  this  peculiar  situation  in  1893  by  stopping  the  free  coinage 
of  silver  and  by  making  the  rupee  virtually  an  inconvertible  money.  Thereafter 
the  artificial  price  at  which  the  rupee  was  maintained,  and  the  price  of  Indian 
exchange,  went  together ;  in  fact,  the  price  of  exchange  on  England  registered 
and  determined  the  pries  of  the  rupee. 


THE  FOREIGN  EXCHANGES  465 

have  an  effect  on  international  trade.  That  effect,  again,  has 
the  appearance  of  being  wrought  by  the  foreign  exchanges, 
yet  in  truth  is  due  to  the  discordance  between  the  price  of 
foreign  bills  (i.e.  the  specie  premium)  and  the  range  of  prices. 
It  has  been  pointed  out *  that  the  specie  premium  does  not 
go  up  and  down  in  any  exact  correspondence  with  general 
prices.  When  it  is  higher  than  prices,  exports  are  stimulated, 
since  the  exporter,  selling  in  a  (foreign)  gold  market,  gets  more 
of  the  current  paper  money.  This  same  influence,  of  course, 
causes  the  prices  of  exported  commodities  to  go  up,  and  stimu- 
lates exports;  they  feel  the  inflation  more  than  most  com- 
modities. On  the  other  hand,  a  specie  premium  lower  than 
general  prices  stimulates  imports,  since  the  importer  finds  it 
easier  to  pay  for  his  goods;  hence  imports  grow  heavier  and 
eventually  cheaper.  Some  writers  have  supposed  that  a  de- 
preciated paper  currency  always  acts  as  a  stimulus  on  exports 
and  a  check  on  imports.  But  there  seems  to  be  no  ground  for 
saying  that  it  necessarily  acts  one  way  or  the  other.  This  sort 
of  influence  depends  on  the  divergence  between  the  gold  premium 
and  the  real  depreciation  of  the  paper,  which  may  be  in  either 
direction. 

The  relation  of  imports  to  exports,  again,  has  a  reciprocal 
influence  on  the  specie  premium.  If  there  be  an  increase  of 
exports,  such  as  may  readily  occur  because  of  crop  changes 
or  altered  demand,  more  bills  are  offered  on  foreign  countries 
(presumably  specie  countries).  Then  the  price  of  foreign  ex- 
change falls,  and  the  premium  on  specie  necessarily  falls  with 
it.  In  the  long  run  the  depreciation  of  the  paper  and  the 
specie  premium  will  depend  on  the  quantity  of  the  paper  in 
its  relation  to  the  quantity  of  goods.  But  the  state  of  foreign 
trade  and  the  relation  of  imports  to  exports  has  a  proximate 
effect  on  the  exchanges  and  the  specie  premium.  A  country 
which  is  preparing  to  return  from  paper  money  to  a  specie  basis 
finds  resumption  of  specie  payments  easier  if  the  period  fixed 

1  See  above,  Book  III,  Chapter  23,  §  2. 
2  ii 


466  INTERNATIONAL  TRADE 

for  the  transition  happens  to  be  one  of  large  exports  and  low 
price  of  exchange. 

§  8.  "Domestic  exchange,"  so-called,  presents  the  same 
phenomena  as  foreign  exchange,  only  less  conspicuously.  In 
Chicago,  exchange  on  New  York  is  sold,  just  as  in  New  York 
exchange  on  London  is  sold;  and  the  course  of  exchange  and 
the  limits  in  the  fluctuations  are  determined  in  precisely  the 
same  way.  Payments  have  to  be  made  constantly  in  New 
York  by  Chicago  merchants  who  have  bought  goods  there; 
they  buy  exchange  (i.e.  drafts)  on  New  York.  Other  mer- 
chants in  Chicago  have  sold  commodities  in  New  York, 
and  draw  on  their  New  York  debtors.  They  sell  exchange 
on  New  York.  As  in  the  case  of  foreign  exchange,  all  these 
transactions  take  place  through  the  bankers  as  middlemen. 
When  the  two  debts  to  be  settled  are  equal,  exchange  is 
at  par.  When  there  are  larger  payments  to  be  made  in  New 
York  than  to  be  demanded  thence,  money  must  be  sent  to 
New  York  in  settlement  of  the  balance.  Then  New  York  ex- 
change, or  New  York  "funds,"  go  to  a  premium  in  Chicago. 
That  premium  is  limited  by  the  cost  of  shipping  money,  with 
the  loss  of  interest  during  the  period  of  shipment.  Both  items 
of  expense  are  of  course  much  smaller  than  in  the  correspond- 
ing case  of  foreign  exchange.  The  express  companies  charge 
forty  cents  per  $1000  for  carrying  money  from  New  York  to 
Chicago ;  the  cash  goes  from  one  place  to  the  other  in  twenty- 
four  hours.  New  York  funds  in  Chicago  can  go  a  trifle  above 
or  below  par,  but  only  a  trifle. 

Just  as  foreign  exchange  settlements  are  made  largely  through 
London  as  the  international  financial  center,  so  domestic  ex- 
change settlements  are  made  in  the  United  States  chiefly 
through  New  York  as  the  domestic  financial  center.  When 
a  merchant  in  Memphis  wishes  to  remit  to  one  in  Boston,  he 
commonly  sends  a  draft  on  New  York;  for  such  a  draft  is 
acceptable  in  Boston  or  in  any  other  place.  The  banks  through- 
out the  country  are  in  constant  correspondence  with  those  in 
the  metropolis,  remitting  to  them  and  drawing  on  them.  The 


THE  FOREIGN  EXCHANGES  467 

closeness  of  this  relation  is  of  course  strengthened  by  the  re- 
serve deposit  system  of  our  national  banks.  The  clearing 
house  hi  New  York  is  a  clearing  house  for  the  entire  country. 
There  drafts  meet  and  are  exchanged.  To  or  from  New  York 
actual  shipments  of  cash  are  chiefly  made. 

So  small  are  the  premiums  and  discounts  on  domestic  ex- 
change that  they  are  commonly  not  paid  by  the  banks  to 
those  of  their  customers  who  draw  on  other  places,  nor  are 
they  charged  to  customers  who  have  remittances  to  make  in 
other  places.  The  banks  deal  in  domestic  exchange  among 
themselves.  Sometimes  New  York  funds  hi  a  given  city, 
Chicago  or  Boston,  are  at  a  premium  among  banks,  sometimes 
at  a  discount.  But  the  banks  as  a  rule  do  not  trouble  their 
customers  with  these  trifling  charges,  but  supply  them  with 
New  York  drafts  at  par  and  take  their  New  York  drafts  at  par. 

Before  the  days  of  railways  and  of  the  safe  and  expeditious 
shipment  of  money,  domestic  exchange  was  a  serious  matter  in 
the  United  States,  more  serious  than  foreign  exchange  now  is. 
In  the  first  third  of  the  nineteenth  century,  Cincinnati  was  as 
far  from  New  York  as  was  London.  The  shipment  of  money, 
moreover,  then  meant  the  shipment  of  bulky  silver.  Hence 
exchange  was  subject  to  considerable  fluctuations,  —  fluctua- 
tions which  were  often  increased  by  the  disordered  state  of  the 
country's  currency,  just  as  fluctuations  in  foreign  exchange 
are  increased  by  depreciated  paper.  One  of  the  most  profit- 
able parts  of  the  business  of  banks  in  those  days  was  the  pur- 
chase and  sale  of  domestic  exchange ;  while,  on  the  other  hand, 
the  uncertainties  of  domestic  remittances  were  a  serious  obstacle 
to  the  geographical  division  of  labor  within  the  country.  Dur- 
ing the  time  when  the  Bank  of  the  United  States  (especially 
the  Second  Bank,  1817-1837)  was  in  existence,  it  did  much  to 
lessen  these  fluctuations  and  uncertainties,  and  thereby  per- 
formed one  of  its  most  useful  functions.  In  our  own  day  the 
establishment  of  a  uniform  currency  throughout  the  land,  and 
the  vast  cheapening  and  expediting  of  transportation  by  rail- 
ways, have  brought  the  fluctuations  in  domestic  exchange 
within ,  limits  so  narrow  as  to  make  them  almost  negligible. 


CHAPTER  33 
THE  BALANCE  OF  INTERNATIONAL  PAYMENTS 

§  1.  In  the  preceding  chapter,  foreign  trade  has  been  treated 
as  if  imports  and  exports  of  merchandise  were  the  only  items 
in  the  balance  of  foreign  payments.  But  there  are  other  items, 
often  of  great  importance. 

Among  the  most  considerable  of  these  are  lending  and  bor- 
rowing between  countries,  or  rather,  lending  and  borrowing 
between  individuals  in  different  countries.  Loans  contracted 
by  governments  play  their  part,  —  public  borrowings  from 
persons  in  foreign  countries ;  but  much  the  larger  part  of  these 
transactions  is  between  individuals.  There  is  a  prevalent 
mode  of  speech  concerning  foreign  borrowings,  and  indeed 
foreign  transactions  generally,  as  if  they  took  place  between 
nations,  —  as  if  Germany  bought  goods  from  France,  and  the 
United  States  borrowed  from  England.  What  really  happens 
is  that  individuals  in  one  country  are  buying  or  borrowing 
from  individuals  in  another.  The  habit  of  personifying  coun- 
tries, while  often  convenient  for  brevity,  promotes  or  covers  up 
a  misunderstanding  of  the  actual  situation,  and  sometimes 
foments  unreasonable  prejudice. 

Suppose  persons  in  the  United  States  to  borrow  from  per- 
sons in  England.  In  the  course  of  such  transactions,  entered 
on  with  a  view  to  investment  in  the  United  States,  the  English 
lenders  are  usually  bankers,  upon  whom  American  borrowers 
become  entitled  to  draw  for  the  sums  lent.  The  Americans 
have  bills  on  London  to  sell.  If  imports  and  exports  have 
balanced  before,  there  are  now  more  bills  on  London  offered 
in  New  York  than  the  importers  wish  to  buy.  Foreign  exchange 
falls  in  price  and  specie  flows  to  the  United  States.  If,  indeed, 
these  same  borrowing  Americans  happen  to  make  purchases  in 
England;  if,  for  example,  they  are  railway  projectors  and 

468 


THE  BALANCE  OF  INTERNATIONAL  PAYMENTS     469 

buy  rails  at  once  in  England  (a  common  transaction  in  the 
second  and  third  quarters  of  the  nineteenth  century),  —  then 
they  may  send  their  London  bills  directly  to  the  rail  makers 
in  that  city.  In  so  far,  the  loan  may  be  effected  by  the  im- 
mediate import  of  commodities  and  without  any  flow  of  specie. 
But  such  a  combination  of  borrowing  and  purchase  is  by  no 
means  universal.  Ordinarily,  the  borrower  wants  money,  or 
purchasing  power ;  he  may  use  his  purchasing  power  at  home, 
or  in  the  lender's  country,  or  in  a  third  country.  The  loan  is 
likely  to  bring  in  the  first  instance  a  fall  in  foreign  exchange  in 
the  borrower's  country,  and  a  flow  of  specie  into  that  country. 

If  this,  however,  goes  on  year  after  year,  the  same  effect  is 
produced  on  foreign  trade  as  if  there  were  an  excess  of  imports 
into  England.  The  flow  of  specie  will  not  go  on  indefinitely. 
There  will  be  an  effect  on  prices  in  England  and  the  United 
States,  such  as  will  stimulate  exports  from  England  and  im- 
ports into  the  United  States.  The  imports  into  the  United 
States  will  not  necessarily  be  from  England;  there  may  be 
greater  American  purchases  in  third  countries  or  greater  Eng- 
lish sales  in  third  countries,  or  there  may  be  both.  The  effect 
is  likely  to  come  gradually  and  almost  insensibly,  through  a 
little  noticed  diversion  of  the  usual  flow  of  specie,  and  through 
changes  in  prices  that  are  slight  and  seem  on  the  surface  due 
to  other  causes.  But  experience  has  abundantly  proved  that 
a  continuing  balance  of  this  kind,  like  a  continuing  balance 
arising  from  merchandise  transactions,  is  not  liquidated  in 
specie.  It  is  settled  by  an  increase  of  merchandise  exports 
from  the  lending  country.  Such  a  country  shows  before  long 
an  excess  of  exports,  and  this  supplies  the  wherewithal  for 
remittances  to  the  borrowing  country. 

Transactions  of  this  kind  are  not  usually  sporadic.  They 
give  rise  to  a  steady  flow  of  remittances,  to  which  the  mer- 
chandise exports  and  imports  accommodate  themselves.  For 
a  long  time  England  and  France  have  been  lending  countries, 
and  Germany  has  recently  become  one.  Such  countries,  in  the 
earlier  stages  of  lending,  show  an  excess  of  merchandise  exports 


470  INTERNATIONAL  TRADE 

over  imports,  and  yet  no  steady  discount  on  foreign  exchange 
and  no  outflow  of  specie.  The  continuing  loans  are  effected 
by  the  exportation  of  goods.  The  process  is  one  of  which 
neither  the  lending  individuals  nor  the  exporting  merchants 
are  conscious.  The  influence  of  specie  flow  and  of  changing 
prices  is  often  gradual,  silent,  and  little  observed.  Sometimes 
it  is  accompanied,  in  the  borrowers'  country,  by  rapidly  rising 
prices,  extending  credit,  active  business,  speculation,  general 
surface  prosperity,  and  in  the  end  a  halt  to  the  movement  from 
an  industrial  and  financial  crisis.  In  the  United  States  crises 
have  commonly  been  accompanied,  during  the  period  of  incu- 
bation, by  heavy  borrowing  from  abroad,  at  first  an  inflow  of 
specie,  then  rising  prices,  and  gradually  an  increase  of  imports. 
Suppose  now  that  the  process  of  borrowing  has  gone  on  for 
a  long  series  of  years.  Then  another  factor  enters;  and  in 
time  the  situation  is  inverted.  The  borrowers  have  to  pay 
interest  on  their  loans.  As  more  and  more  loans  are  made,  the 
annual  interest  charge  swells.  The  principal  of  each  loan  is  re- 
mitted once  for  all ;  but  the  interest  charge  to  which  it  gives 
rise  goes  on  year  after  year.  In  time  the  interest  payments 
that  must  be  made  to  the  creditors'  country  will  equal,  and 
eventually  will  exceed,  the  payments  on  account  of  new  loans 
which  are  made  to  the  debtors'  country.  To  this  new  situation, 
also,  the  imports  and  exports  will  in  time  adapt  themselves. 
The  lending  country,  which  at  the  outset  had  an  excess  of  ex- 
ports, will  in  the  end  have  an  excess  of  imports.  From  England 
loans  have  been  made  for  a  century  to  all  parts  of  the  world. 
Though  loans  continue  still  to  be  made,  the  interest  charges  on 
the  old  loans  now  much  exceed  the  amounts  newly  sent  out 
on  principal  account.  Hence  the  foreign  trade  of  Great  Britain 
shows  a  large  excess  of  merchandise  imports  over  exports,  — 
an  excess,  it  is  true,  due  partly  to  other  causes,  but  mainly  due 
to  this  one.1 

1  The  capital  sums  invested  by  the  British  people  in  other  lands  are  put  at  the 
enormous  total  of  £2,700,000,000  ($13,500,000,000),  and  the  amount  annually 
payable  to  persons  in  Great  Britain  at  £140,000,000  ($700,000,000).  Journal 
of  the  Royal  Statistical  Society,  September,  1909. 


THE  BALANCE  OF  INTERNATIONAL  PAYMENTS      471 

The  transition  in  the  borrowers'  country  from  an  excess  of 
credit  charges  to  one  of  debit  charges  —  from  an  excess  of 
merchandise  imports  to  an  excess  of  merchandise  exports  — 
may  take  place  slowly  and  silently,  or  may  be  accompanied 
by  a  financial  crash.  The  turning  point  in  the  United  States 
seems  to  have  come  with  the  crisis  of  1873.  As  will  be  pointed 
out  presently,  the  foreign  trade  of  the  United  States  changed 
in  its  character  after  that  year;  a  previous  excess  of  imports 
was  replaced  by  an  excess  of  exports.  Though  the  shift  was 
not  due  solely  to  the  new  relations  of  principal  and  interest  in 
the  international  lending  account,  this  seems  to  have  been  the 
dominant  cause.  It  is  not  strange  that  the  transition  should 
be  initiated  by  a  crisis,  and  that  the  first  phase  of  it  should 
be  a  period  of  business  depression. 

The  great  lending  operations  of  modern  times  take  place 
chiefly  through  the  sale  of  securities.  When  governments 
borrow,  they  sell  their  evidences  of  debt.  When  loans  are 
secured  for  private  enterprises,  corporate  stocks  and  bonds  are 
usually  sold.  The  result  of  long-continued  operations  of  this 
sort  has  been  that  certain  securities  have  an  international 
market,  and  pass  freely  from  country  to  country.  They  are 
largely  used  in  settlement  of  international  balances,  and  often 
obviate  a  flow  of  specie.  Especially  is  this  the  case  where  a 
temporary  balance  of  payments  has  to  be  met.  Then  the 
bankers  through  whom  bills  of  exchange  are  bought  may  send 
such  securities  instead  of  specie.  On  the  other  hand,  these 
transactions  sometimes  cause  independent  disturbances  of  for- 
eign trade,  and  so  of  banking  and  financial  conditions.  If  the 
securities  issued  by  a  country's  government  or  its  corporations 
come  to  be  distrusted,  they  are  likely  to  be  sent  back  to  that 
country  for  sale,  and  then  to  cause  a  balance  of  specie  to  leave 
that  country.  Thus  in  the  years  from  1890  to  1896,  when  the 
contest  over  the  gold  and  silver  standards  was  going  on  in  the 
United  States,  foreign  holders  of  American  securities  became 
uneasy  and  sent  the  securities  to  the  New  York  stock  exchange 
for  sale,  —  a  movement  which  contributed  to  the  outflow  of 


472  INTERNATIONAL  TRADE 

specie  during  those  years,  and  added  to  the  causes  of  public 
and  private  embarrassment. 

§  2.  Transactions  other  than  loans  affect  international  trade. 
One  of  the  simplest  is  that  of  payments  made  to  persons  liv- 
ing or  traveling  in  a  foreign  country.  American  travelers  in 
Europe,  and  those  who  have  permanently  established  them- 
selves there,  spend  annually  many  millions  of  dollars,  —  not 
less,  in  recent  times,  than  $100,000,000  a  year.  What  they 
spend  is  put  at  their  command  in  Europe  through  the  mechan- 
ism of  the  foreign  exchanges.  Usually  they  have  letters  of 
credit,  which  enable  them  to  draw  on  bankers.  Their  drafts 
appear  in  the  foreign  exchange  market  precisely  as  do  the 
drafts  of  persons  who  have  exported  goods  to  the  United  States. 
If  the  merchandise  exports  and  imports  of  the  United  States 
just  balanced,  then  these  travelers'  drafts  would  cause  ex- 
change on  the  United  States  to  be  regularly  at  a  discount  in 
Europe,  and  specie  would  flow  from  the  United  States.  But 
to  this  situation,  as  to  that  arising  from  loans  and  interest  pay- 
ments, the  merchandise  trade  has  adjusted  itself.  The  sums 
which  Americans  spend  abroad  are  supplied  by  an  excess  of 
merchandise  exports  from  the  United  States ;  an  excess  which 
has  been  brought  about  gradually  and  insensibly,  in  obedience 
to  the  same  causes  which  would  bring  the  exports  and  imports 
to  a  precise  equality  if  these  alone  constituted  international 
dealings.  In  the  same  way,  British  India  has  an  excess  of 
exports ;  partly  because  there  are  interest  charges  on  loans  of 
long  standing  made  by  Englishmen  to  the  government  of  India 
and  to  private  persons  there ;  partly  because  there  are  in  Eng- 
land many  pensioners  from  the  Indian  service,  to  whom  the 
Indian  government  must  make  regular  remittances. 

A  curious  and  important  addition  to  the  payments  of  this 
kind  has  come  in  the  United  States,  since  about  1890,  from  the 
remittances  of  immigrants  to  their  kinsfolk  in  the  old  countries. 
The  immigrants  newly  arrived  are  frugal ;  it  is  the  second  genera- 
tion that  accepts  the  more  liberal  spending  ways  of  the  pros- 
perous country.  The  newly  arrived  send  a  good  part  of  their 


THE  BALANCE  OF  INTERNATIONAL  PAYMENTS     473 

savings  to  relatives  and  friends  at  home,  very  largely  for  the 
purpose  of  enabling  these  also  to  emigrate  to  the  land  of  plenty. 
Thereby  again  a  debit  item  appears  in  the  foreign  exchange 
operations,  which  adds  to  the  causes  bringing  an  excess  of  mer- 
chandise exports.  This  item  reached  surprising  size  hi  the 
first  decade  of  the  present  century ;  it  was  supposed  to  amount 
in  each  year  to  at  least  $150,000,000. 

Freight  charges  form  another  item  of  the  same  sort.  If  the 
merchandise  between  two  countries  is  carried  solely  in  the 
ships  of  one  of  them,  this  one  will  have  in  so  far  a  balance  due 
to  it.  Thus  the  foreign  trade  of  the  United  States  is  now 
carried  on  chiefly  in  the  vessels  of  other  countries,  England 
having  the  largest  share.  The  citizens  of  the  United  States 
make  remittances  on  freight  account;  and  they  would  have 
to  make  them  by  the  shipment  of  specie  if  the  exports  just 
balanced  the  imports.  England  is  in  the  contrary  case.  Her 
people  are  great  owners  of  vessels,  and  are  carriers  the  world 
over.  By  itself,  this  factor  would  bring  specie  into  England  if 
her  imports  just  balanced  her  exports.  As  a  matter  of  fact, 
the  remittances  that  must  be  made  from  the  United  States  for 
freight  and  those  that  England  receives  from  the  United  States 
as  well  as  from  other  countries,  take  their  place  in  the  general 
balance  of  international  payments.  They  also  add  to  the 
causes  which  lead  in  the  United  States  to  an  excess  of  mer- 
chandise exports,  and  in  England  to  an  excess  of  merchandise 
imports. 

§  3.  A  country  which  produces  specie,  and  especially  in 
modern  tunes  one  which  produces  gold,  is  in  a  peculiar  situa- 
tion. If  this  be  the  only  item  (or  the  dominant  item)  over 
and  above  ordinary  merchandise  transactions,  the  country 
will  have  regularly  an  excess  of  merchandise  imports,  just  as 
it  would  have  if  travelers'  expenses  or  freight  charges  had  to 
be  remitted  to  it.  But  it  will  also  have  a  regular  outflow  of 
specie ;  and  therefore  foreign  exchange  will  be  regularly  at  a 
premium.  The  specie  is  in  this  case  an  ordinary  article  of 
export,  like  wheat  or  cotton  or  any  other  commodity.  But  it 


474  INTERNATIONAL  TRADE 

goes  out  only  when  the  state  of  the  foreign  exchanges  is  such 
as  to  warrant  its  shipment.  In  the  other  cases  where  a  coun- 
try has  an  excess  of  merchandise  imports,  foreign  exchange  is 
not  ordinarily  either  high  or  low;  it  reaches  the  shipping 
points  only  on  the  sporadic  occasions  of  balances  to  be  met. 
But  in  a  mining  country  the  state  of  the  exchanges  is  normally 
such  as  to  cause  the  exportation  of  specie.  This  was  the  case 
in  the  gold-mining  colonies  of  Australia,  especially  Victoria, 
for  many  years  after  the  gold  discoveries  of  1850;  and  it  is 
still  in  the  main  the  case  in  that  region.  It  was  the  case  in 
Mexico,  long  the  greatest  silver-mining  country  in  the  world, 
during  the  period  when  silver  was  specie  on  the  same  terms 
with  gold.  Since  the  universal  adoption  of  the  gold  standard, 
and  its  introduction  even  into  Mexico,  silver  has  there  become 
a  commodity  like  any  other,  and  the  exchanges  are  reckoned 
on  a  gold  basis.  For  the  first  decade  after  the  Californian  gold 
discoveries  of  1850,  the  United  States  was  in  the  same  position 
as  Australia. 

The  more  recent  experiences  of  the  United  States,  with 
regard  to  the  domestic  output  of  gold,  illustrate  some  of  the 
irregularities  of  international  trade,  and  show  in  what  complex 
ways  the  underlying  forces  work  out  their  results.  During  the 
Civil  War,  the  gold  in  circulation  was  driven  out  by  the  issue 
of  paper  money ;  and  thereafter,  until  the  resumption  of  specie 
payments  in  1879,  the  annual  product  of  the  mines  was  steadily 
exported,  gold  and  silver  being  alike  regular  articles  of  export. 
Since  1879,  the  United  States  has  accumulated  an  immense 
stock  of  gold.  It  has  done  so  very  largely  by  the  simple  reten- 
tion within  her  own  borders  of  the  output  of  the  domestic 
mines.  In  some  years,  not  only  has  this  product  been  retained, 
but  much  gold  has  flowed  in  from  abroad  in  addition.  Though 
it  has  happened,  in  other  years,  that  not  only  the  yield  of  the 
mines  has  been  exported,  but  even  more ;  yet  on  the  whole,  the 
domestic  product,  and  something  more,  has  accumulated  in 
the  country.  The  course  of  prices  has  been  affected  by  these 
movements,  through  those  processes  whose  slow,  irregular,  and 


THE  BALANCE  OF  INTERNATIONAL  PAYMENTS     475 

half-concealed  working  has  been  explained  in  the  preceding 
pages. 

§  4.  A  glance  at  the  figures  of  the  imports  and  exports  of  the 
United  States  during  the  last  hundred  years  shows  that  a 
striking  change  in  the  relation  of  the  two  items  took  place  in 
1873.  Up  to  that  date,  imports  had  regularly  exceeded  the 
exports;  since  that  date,  exports  have  regularly  exceeded  the 
imports.  The  excess  of  exports  in  the  early  years  of  the 
twentieth  century  was  enormous ;  during  the  decade  ending  in 
1908  the  annual  excess  was  $500,000,000.  The  reversal  in  1873 
is  easily  explicable,  from  what  has  been  stated  in  the  preceding 
pages.  During  the  first  three  quarters  of  the  nineteenth  cen- 
tury, the  United  States  had  been  a  borrowing  country ;  and  it 
had  been  in  the  early  stages  of  borrowing,  —  steady  recurrences 
of  new  loans  more  than  balanced  the  accruing  interest  on  old 
loans.  Until  1860  the  United  States,  in  addition,  had  been  a 
shipping  and  freight-carrying  country,  and  its  shipowners  had 
been  earning  freights  payable  by  persons  in  other  countries. 
After  1873,  though  borrowing  continued,  sometimes  on  a  great 
scale,  the  annual  interest  payable  to  foreigners  on  the  whole 
offset  the  remittances  into  the  country  on  capital  account. 
Freight  charges  became  payable  by  Americans  to  foreigners, 
no  longer  by  foreigners  to  Americans ;  for  the  reason,  mainly, 
that  iron  steamers  displaced  wooden  sailing  vessels  and  could 
be  built  and  operated  more  cheaply  by  the  British  and  by 
others  in  Europe.  On  the  other  hand,  debit  items  appeared 
newly,  or  rose  to  dimensions  so  much  greater  as  to  make  them 
substantially  new.  The  traveling  expenses  of  Americans  be- 
came vastly  larger ;  so  did  the  remittances  of  immigrants.  In 
some  years,  repayments  of  old  loans  were  made,  in  the  form  of 
purchases  by  Americans  of  securities  which  in  previous  tunes 
had  been  sold  abroad.  Hence  the  preponderance  of  exports 
after  1873,  at  first  comparatively  slight,  eventually  reach- 
ing the  remarkable  extent  just  stated.  Irregular  as  the  mer- 
chandise balances  were,  influenced  as  they  necessarily  were  by 
the  accidents  of  the  season  and  the  crops,  by  monetary  legis- 


476  INTERNATIONAL  TRADE 

lation,  by  crises  and  depressions  and  "booms,"  the  general 
trend  was  unmistakable ;  the  exports  advanced  more  rapidly 
than  the  imports,  exceeded  them  in  almost  every  single  year, 
and  in  most  years  exceeded  them  immensely.  The  flow  of 
specie  meanwhile  was  at  some  times  into  the  United  States, 
in  other  times  out  of  the  United  States ;  on  the  whole,  as  might 
be  expected,  more  pronouncedly  into  the  United  States  during 
the  later  years  of  very  heavy  exports.  The  redistribution  of 
gold,  which  was  part  of  the  general  movement,  took  place,  as 
has  been  noted  in  a  preceding  paragraph,  very  largely  by  the 
more  or  less  complete  retention  within  the  country  of  the 
product  of  its  own  mines.1 

§  5.  When  the  merchandise  exports  of  a  country  exceed  its 
imports,  the  country  is  said  to  have  a  "favorable  balance"  of 
trade.  When  its  imports  exceed  its  exports,  the  balance  is 
said  to  be  "unfavorable."  The  same  terms  are  used  when  the 
state  of  international  trade  is  such  as  to  cause  an  inflow  or 
outflow  of  specie ;  although,  as  we  have  seen,  such  inflow  or  out- 
flow is  by  no  means  a  necessary  or  even  a  usual  consequence 
of  an  excess  or  deficiency  of  exports.  The  general  notion 
underlying  these  terms  is  that  a  country  gains  by  having 
dealings  with  other  countries  which  are  expected  to  bring 
specie  in,  and  loses  by  those  which  are  expected  to  take  specie 
out. 

This  notion  goes  back  to  the  Mercantile  writers  of  the  seven- 
teenth and  eighteenth  centuries,  who  believed  that  specie  was 
a  peculiarly  important  part  of  a  country's  wealth,  and  that 
legislation  on  international  trade  should  be  directed  to  its  accu- 
mulation. Any  one  who  has  grasped  the  elementary  truths 
about  utility,  wealth,  exchange,  money,  will  see  the  absurdity 
of  supposing  that  the  prosperity  of  a  country  is  bound  up 

1  Figures  for  the  merchandise  imports  and  exports  and  for  the  flow  of  gold  are 
given  in  every  edition  of  the  Statistical  Abstract.  Estimates  have  been  made 
from  time  to  time  of  the  amounts  of  the  various  non-merchandise  items,  such  as 
interest  and  freight  charges,  tourists'  expenses,  immigrants'  remittances ;  for  ex- 
ample, by  Mr.  T.  Bacon,  in  the  Yale  Review,  1900,  and  for  1909  by  Mr.  G.  Paish, 
in  a  monograph  on  the  Trade  Balance  of  the  United  States,  a  publication  of  the 
United  States  Monetary  Commission. 


THE  BALANCE  OF  INTERNATIONAL  PAYMENTS     477 

with  the  inflow  or  outflow  of  specie.  The  astonishing  thing  is 
that,  notwithstanding  the  simplicity  of  those  truths  and  their 
repeated  and  widespread  exposition,  ignorance  regarding  them 
should  be  so  common.  Many  people  who  think  themselves 
entitled  to  attention  stiii  speak  as  if  an  excess  of  exports  promised 
a  profit  to  a  country,  and  an  influx  of  specie  were  a  realization 
of  that  profit. 

In  part,  this  way  of  looking  at  international  trade  comes 
from  the  habitual  attitude  of  business  men  and  bankers.  Plenti- 
ful bank  reserves,  low  rates  of  discount,  easy  accommodation 
to  borrowers,  —  these  are  always  welcome  to  the  business  com- 
munity. Conversely,  diminishing  bank  reserves  and  higher 
discount  are  unwelcome.  Hence  the  inflow  of  specie,  which 
proximately  affects  bank  holdings  and  short-time  interest, 
is  spoken  of  as  a  good  thing,  and  the  outflow  of  specie  as  a  bad 
thing.  This  outflow,  with  its  consequent  pressure  on  loans, 
interest  rates,  and  eventually  on  prices,  is  often  the  salutary 
check  on  inflation  and  speculation.  But  few  business  men  feel 
it  to  be  salutary.  Nearly  all  would  like  to  see  an  unending 
round  of  rising  prices. 

There  are  times,  of  course,  when  the  balance  of  international 
payments  —  usually  resting  on  the  relation  between  exports 
and  imports  —  is  of  real  consequence.  This  is  notably  the 
case  when  a  country  is  trying  to  extricate  itself  from  a  depre- 
ciated paper  currency.  The  return  to  specie  payments  is 
possible  for  such  a  country  only  if  its  foreign  trade  is  in  a 
state  which  will  cause  specie  to  flow  in,  or  will  prevent  it  from 
flowing  out  when  a  fund  for  resumption  purposes  has  been 
collected  by  the  government.  Though  in  the  long  run  this  inflow 
or  outflow  will  depend  on  the  state  of  prices,  in  any  one  season 
the  balance  of  international  payments  is  affected  by  the  seasonal 
events.  If,  at  the  time  when  a  country  is  preparing  to  return 
to  a  specie  basis,  financial  disturbances  or  poor  crops  lead  to 
an  *'  unfavorable "  balance,  the  operation  of  resumption  will  be 
difficult  and  perhaps  unsuccessful.  It  was  an  immense  aid  to 
the  resumption  of  specie  payments  by  the  United  States  that 


478  INTERNATIONAL  TRADE 

in  the  year  fixed  for  it  (1879)  and  in  the  years  immediately 
following  there  were  unusually  heavy  exports,  due  to  good  crops 
within  the  country  and  poor  crops  elsewhere ;  while  at  the 
same  period  improvements  in  railway  transportation  greatly 
facilitated  an  increase  of  exports.  The  consequent  inflow  of 
gold,  coupled  with  the  retention  of  the  domestic  output  of  the 
metal,  gave  an  unexpectedly  solid  basis  to  the  reestablished 
specie  regime. 

In  the  main,  however,  the  persistence  of  the  Mercantilist 
attitude  is  not  due  to  any  such  considerations  of  real  advantage, 
but  to  simple  ignorance.  People  measure  their  individual  in- 
comes in  terms  of  money,  profit  by  an  excess  of  money  receipts 
over  money  expenses,  and  fall  into  the  way  of  regarding  money 
as  the  important  form  of  wealth.  This  was  indeed  the  earliest 
and  crudest  form  of  the  Mercantilist  notion.  The  same  igno- 
rance and  fallacy  underlie  the  advocacy  of  paper  money  in- 
flation, and  the  various  schemes  for  making  nations  prosperous 
by  adding  to  their  stocks  of  cash. 

One  curious  form  of  the  Mercantilist  view  appears  in  the 
interpretation  often  given  to  the  state  of  trade  between  a 
country  and  a  single  one  of  its  neighbors.  Thus  the  exports 
from  Canada  to  the  United  States  may  be  greater  than  the 
exports  from  the  United  States  to  Canada;  and  it  is  often 
inferred  (for  example,  in  discussion  of  reciprocity  treaties  be- 
tween the  two  countries)  that  the  trade  is  one  unfavorable  or 
damaging  to  the  United  States.  Such  comparison  is  meaning- 
less. So  far  as  the  relation  between  imports  and  exports  is  a 
matter  of  moment  at  all,  this  is  to  be  judged  by  the  balance  of 
transactions,  not  between  any  one  country  and  a  single  other, 
but  by  its  balance  with  all.  That  our  exports  to  England 
exceed  our  imports  thence,  or  our  imports  from  Brazil  exceed 
our  exports  thither,  —  all  this  signifies  nothing.  It  must  be 
confessed  that  public  men  in  high  station,  as  well  as  newspaper 
scribblers  and  rabid  partisans,  fall  into  loose  talk  on  this  sub- 
ject, and  compare  the  sales  and  purchases  of  one  pair  of  coun- 
tries as  if  these  really  gave  an  indication  of  their  relative  gains 


THE  BALANCE   OF  INTERNATIONAL  PAYMENTS     479 

from  trade  with  each  other.  The  real  advantages  from  inter- 
national trade,  and  the  relative  gains  of  different  countries, 
are  to  be  gauged  in  a  very  different  way,  as  will  appear  in  the 
chapters  to  follow. 


CHAPTER  34 

THE  THEORY  OF  INTERNATIONAL  TRADE.     WHY  PARTICULAR 
GOODS  ARE  EXPORTED  OR  IMPORTED 

§  1.  The  preceding  chapters  have  considered  chiefly  the 
mechanism  of  international  trade.  We  may  proceed  now  to 
matters  more  fundamental :  the  variations  in  prices  and  money 
incomes  in  different  countries,  the  causes  which  determine 
what  commodities  a  country  shall  import  or  export,  the  real 
importance  of  specie  movements  between  countries  and  of 
a  rise  or  fall  in  the  value  of  money,  the  real  gain  from  inter- 
national trade.  The  first  topics  for  consideration  will  be  the 
mode  in  which  a  country's  exports  and  imports  are  determined, 
and  the  cause  and  significance  of  variations  in  prices  and 
incomes. 

We  shall  assume,  for  simplicity,  that  trade  is  free.  Duties 
on  imports  have  important  modifying  effects,  but  these  can  be 
understood  better  if  the  working  of  unfettered  trade  is  first 
examined. 

Let  us  begin  by  calling  to  mind  some  familiar  but  often 
neglected  facts,  known  to  all  observers,  but  rightly  interpreted 
by  few.  Among  the  most  familiar  is  that  there  are  differences 
in  the  value  of  money  in  different  countries  ;  that  is,  differences 
in  the  range  of  prices  and  of  money  incomes.  It  will  appear 
later  in  our  inquiry  that  the  differences  in  money  incomes  are 
the  more  important,  and  that  prices  do  not  always  move  with 
money  incomes;  but  for  the  present  we  may  assume  that 
prices  and  money  incomes  in  general  move  together.  Money 
wages  and  other  money  incomes,  and  most  prices  also,  are  higher 
in  the  United  States  than  in  England,  higher  in  England  than 
in  France  and  Germany,  higher  in  these  latter  countries  than 
in  Italy  and  Spain ;  and  lowest  in  countries  like  Japan,  India, 
China. 

480 


THE  THEORY  OF  INTERNATIONAL  TRADE          481 

While  these  differences  are  obvious  in  money  incomes,  and 
in  the  prices  of  many  goods,  it  is  equally  obvious  that  some 
commodities  differ  but  little  in  price  in  the  various  countries. 
These  are  the  commodities  which  are  the  objects  of  inter- 
national trade,  —  which  move  from  country  to  country  as 
imports  and  exports.  These,  if  we  set  aside  cost  of  transpor- 
tation, are  the  same  in  price  in  all  the  trading  countries.  Where 
cost  of  transportation  is  considerable,  their  prices  may  vary 
considerably ;  hence  we  can  only  say  that  the  prices  tend  to  be 
not  far  from  the  same.  We  neglect,  for  the  present,  it  will  be 
remembered,  differences  due  to  duties  on  imports  or  exports. 
Some  further  qualifications  to  the  general  proposition  would 
have  to  be  made  if  it  were  attempted  to  fit  it  with  exactness 
to  all  the  facts.  Sometimes  an  unfamiliar  commodity  goes 
from  one  country  to  another,  is  bought  very  cheap  by  traders 
in  the  one  and  sold  very  dear  in  the  other;  there  is  a  serious 
difference  in  price.  This  is  likely  to  happen  where  discoveries 
or  rapid  improvements  in  communication  cause  new  oppor- 
tunities for  trade  to  arise.  But  mercantile  competition  tends 
in  time  to  wipe  out  these  differences.  Here,  as  in  other  direc- 
tions, the  pioneers  make  money ;  unusual  profits  are  presently 
cut  away;  in  the  end,  only  such  differences  in  price  persist 
as  are  accounted  for  by  cost  of  transportation  and  the  ordi- 
nary business  returns.  Very  few  propositions  in  economics 
are  literally  and  unfailingly  true ;  they  stand  for  great  general 
tendencies ;  and  among  such  is  the  one  here  stated,  —  that 
goods  which  are  the  subjects  of  a  constant  and  considerable 
foreign  trade  are  sold  at  nearly  the  same  prices  in  all  the  trad- 
ing countries.  Wheat  sells  at  approximately  the  same  price 
in  the  United  States  and  England,  tea  in  the  United  States 
and  Ceylon,  coffee  in  the  United  States  and  Brazil,  wool  in 
Australia  on  the  one  hand,  England,  France,  Germany,  on  the 
other. 

Nearly  the  same  prices,  be  it  noted.  In  order  that  a  com- 
modity shall  move  from  one  country  to  another,  it  must  be 

somewhat   cheaper    in   the   exporting   country,  — cheaper   at 
2  i 


482  INTERNATIONAL  TRADE 

least  by  cost  of  transportation.  International  trade,  like  all 
trade,  though  it  is  resolvable  at  bottom  into  an  exchange  of 
goods  for  goods,  is  proximately  determined  by  prices;  and 
prices  of  the  things  bought  and  sold  must  be  somewhat  lower 
in  the  exporting  country. 

Money  wages,  however,  are  not  necessarily  lower  in  the 
exporting  country.  Thus  they  are  higher  in  the  United  States 
than  in  England,  yet  the  United  States  exports  wheat  to  Eng- 
land. They  are  higher  in  England  than  in  China,  yet  England 
sends  all  sorts  of  manufactured  goods  to  China.  They  are 
higher  in  Australia  than  in  Germany,  yet  Australia  sends  wool 
to  Germany.  A  common  notion  in  regard  to  international 
trade  is  that  a  country  where  wages  are  low  is  a  country  that 
is  peculiarly  likely  to  have  large  exports,  and  that  one  with 
high  wages  has  difficulty  in  sending  out  its  exports.  Yet  a 
moment's  consideration  of  familiar  facts  such  as  have  just 
been  adduced  shows  that  this  cannot  be  the  case.  And  the 
preceding  chapters  have  shown  that  the  exports  of  a  country 
balance  in  money  value  its  imports  (barring  those  differences 
one  way  or  the  other  which  are  easily  explained  by  payments 
other  than  for  merchandise).  The  countries  with  high  money 
wages  have  no  less  exports  than  those  with  low  money  wages. 
In  the  trade  between  the  two  sets  of  countries  neither  can 
export  more  than  the  other;  the  payments  between  them 
balance. 

§  2.  These  preliminary  matters  point  to  the  first  important 
proposition  with  regard  to  international  trade.  A  country 
exports  the  things  which  are  low  in  price  in  its  borders ;  these 
are  things  in  which  its  labor  is  applied  effectively.  Put  in 
words  more  often  used  in  the  literature  of  economics,  a  country 
tends  to  export  those  things  in  which  it  has  a  comparative 
advantage.  And,  conversely,  a  country  tends  to  import  those 
things  which,  if  produced  within  its  borders,  would  be  high  in 
price,  —  those  in .  which  its  labor  would  be  applied  with  less 
effect,  those  in  which  it  has  a  comparative  disadvantage. 

For  example,  wheat  is  exported  steadily  in  large  quantities 


483 

from  the  United  States.1  The  money  incomes  of  those  who 
produce  it  are  high  •  the  farmers  and  their  hired  laborers  are 
well  remunerated.  If  the  price  of  wheat  is  low  in  the  United 
States,  it  must  be  because  the  labor  of  those  who  produce  it  is 
effective.  That  is,  the  labor  is  applied  to  advantage.  High 
wages  and  high  prices  do  not  necessarily  go  together;  high 
wages  are  found  with  low  prices  if  the  productiveness  of  labor 
is  great.  We  speak  now  of  money  wages  alone.  Regarding 
real  wages,  it  will  appear  more  fully  as  we  go  on  that  a  high 
rate  of  wages  is  the  result  of  general  effectiveness  or  productive- 
ness. But  looking  at  money  wages  alone,  and  considering 
them  in  relation  to  international  trade,  we  can  see  clearly  that 
a  high  rate  is  no  obstacle  to  low  prices  and  to  exportation  if 
accompanied  by  great  effectiveness.  If,  on  the  other  hand, 
there  be  high  money  wages  without  any  special  effectiveness, 
then  there  will  be  high  prices.  The  employer  who  must  pay 
high  money  wages,  and  whose  laborers  do  not  produce  abun- 
dantly, must  sell  his  product  at  a  high  price  in  order  to  meet  his 
expenses.  In  a  country  of  high  money  wages  the  producers 
will  continue  to  export  in  those  branches  of  industry  in  which 
the  effectiveness  of  labor  is  large.  The  producers  in  those 
branches  where  the  effectiveness  is  smaller,  will  find  greater 
and  greater  difficulty  in  meeting  foreign  competition,  and  may 
be  driven  out  of  business  by  competing  foreign  imports. 

Again  :  China  exports  tea  and  raw  silk ;  British  India  exports 
jute;  Brazil,  coffee.  These  are  countries  in  which  money  wages 
are  low.  But  they  are  also  countries  in  which  labor  in  general 
is  ineffective.  They  import,  on  the  other  hand,  large  quantities 

1 1  use  wheat  for  illustration,  though  the  exports  are  now  (1909)  declining,  and 
may  cease  in  the  course  of  a  decade.  The  tendency  to  decline  in  these  once  heavy 
exports  is  commonly  ascribed  to  the  fact  that  we  "  need  "  the  domestic  product  for 
our  rapidly  increasing  population.  This  is  true,  as  far  as  it  goes.  But  the 
reason  why  the  product  fails  to  keep  its  former  relation  to  population  and 
"need"  is  the  increasing  cost  (marginal  cost)  of  wheat ;  compare  Book  II,  Chap- 
ter 13,  §  4,  and  Book  V,  Chapter  42.  That  increase  in  cost  means,  in  other 
words,  lessening  effectiveness  and  lessening  comparative  advantage ;  hence  less- 
ening exports.  The  wheat  of  the  Canadian  Northwest  will  probably  supply  in 
the  future  an  illustration  which  will  continue  to  fit  the  text. 


484  INTERNATIONAL  TRADE 

of  manufactured  goods  which  are  produced  more  cheaply  by 
effective  and  highly  paid  labor  in  the  manufacturing  countries. 
They  export  those  things  in  which  their  labor  is  perhaps  in- 
effective, but  is  less  ineffective  than  it  would  be  in  making 
textiles,  hardware,  and  other  manufactures.  They  export  those 
things  in  the  making  of  which  they  have  a  comparative  ad- 
vantage ;  that  is,  those  for  which,  in  their  own  borders,  labor 
is  most  effective. 

Thus  we  reach,  alike  for  countries  with  high  money  incomes 
and  with  low  money  incomes,  the  same  conclusion  :  those  things 
are  comparatively  cheap,  and  those  things  are  likely  to  figure 
in  the  exports,  in  which  the  country's  labor  is  the  more  effective. 

It  matters  not,  for  the  purpose  in  hand,  what  are  the  causes 
of  the  effectiveness  of  labor  which  constitutes  the  country's 
advantage.  It  may  arise  from  climatic  superiority  or  other 
natural  fitness,  or  from  skill  and  aptitude  due  to  complex 
human  causes ;  or  it  may  arise  from  a  combination  of  these. 
The  advantage  of  the  United  States  in  wheat,  and  its  exports 
of  wheat,  rests  (or  rested)  partly  on  the  possession  of  vast 
tracts  of  new  and  fertile  land ;  but  it  was  much  promoted  also 
by  the  intelligence  of  its  farmers  and  their  large  use  of  agricul- 
tural machinery,  and  by  cheap  rail  transportation  from  the 
Western  wheat  fields  to  the  seaports.  All  sorts  of  causes  here 
concur;  not  only  the  obviously  natural  ones,  but  those  con- 
nected with  land  tenure  and  land  ownership,  with  universal 
education  and  universal  ambition,  with  the  influence  on  freight 
rates  of  private  ownership  of  railways  and  hence  of  un- 
fettered enterprise.  However  complex  these  causes,  their 
single  outcome  is  clear :  the  labor  of  producing  and  shipping 
American  wheat  is  effective.  The  same  complexity  of  causes 
lies  back  of  our  exports  of  petroleum  and  of  copper,  —  great 
natural  resources,  but  also  great  enterprise  and  skill  in  develop- 
ing them.  In  some  of  our  exporting  industries,  enterprise  and 
skill  alone,  without  unusual  resources,  suffice  to  explain  effective- 
ness and  cheapness ;  as  in  agricultural  implements,  sewing 
machines,  builders'  hardware,  electrical  equipment.  England's 


THE  THEORY  OF  INTERNATIONAL  TRADE    485 

large  exports  of  manufactures,  which  again  illustrate  the  same 
combination  of  high  money  wages,  effectiveness  of  labor,  com- 
parative advantage,  are  due  partly  to  her  deposits  of  coal  and 
iron  ore,  —  the  natural  foundations  of  manufactures,  —  partly 
perhaps  to  a  favoring  climate,  very  largely  to  the  vigor,  enter- 
prise, and  skill  bred  by  free  industry  and  free  political  institu- 
tions. China's  advantage  (or  less  disadvantage)  in  tea  and 
raw  silk  is  due  partly  to  climate,  partly  to  skill  and  experience 
transmitted  from  generations  to  generations  of  patient  workers. 
That  this  latter  cause  of  advantage  may  be  precarious  is  shown 
by  the  extent  to  which,  in  recent  years,  some  rival  countries 
have  deprived  China  of  her  former  position  as  almost  the  sole 
exporter  of  these  articles.  Ceylon  has  developed  large  exports 
of  tea,  Japan  of  raw  silk,  by  systematic  attention  to  the  best 
ways  of  making  labor  effective  in  producing  these  things. 

§  3.  Cheapness  in  price  being  the  proximate  element  in 
determining  exports,  any  cause  or  set  of  causes  which  makes 
a  commodity  cheap  acts  as  an  advantage  and  so  promotes  ex- 
ports. If  a  particular  kind  of  labor,  though  not  of  high  effective- 
ness, can  be  had  at  very  low  wages,  the  commodities  made  by 
it  are  pro  tanto  likely  to  be  exported. 

Interesting  questions  upon  this  aspect  of  the  problem  are  pre- 
sented by  the  exports  of  cotton  from  the  United  States.  Cli- 
mate, in  its  effects  on  the  quality  of  the  fiber,  may  go  far  to  explain 
these  exports.  But  social  conditions  have  been  supposed  also  to 
be  an  important  factor.  Before  the  Civil  War,  slavery  was 
thought  by  many  to  explain  the  cotton  trade  of  the  South ;  it 
gave  the  advantage  of  very  cheap  labor.  But  the  great  growth 
of  the  exports  since  the  war  (when  once  the  first  years  of  turbulent 
transition  had  passed)  shows  that  slavery  in  itself  was  not  the  con- 
trolling cause.  It  remains  true,  however,  that  cotton  continues 
to  be  grown  mainly  by  negro  labor,  and  that  this  is  cheaper  than 
most  American  labor.  The  maintenance  of  the  exports  may  thus 
be  ascribed  to  the  persistence  of  social  conditions  derived  from 
slavery.  On  the  other  hand,  this  very  negro  labor,  cheap  though 
it  seems  according  to  American  standards,  gets  higher  money 


486  INTERNATIONAL  TRADE 

wages  than  are  current  in  Egypt,  India,  and  other  countries  from 
which  a  competing  supply  of  cotton  comes  to  the  world's  markets. 
The  labor  must  be  at  least  to  some  degree  effective.  Further, 
much  American  cotton  is  grown  (in  Texas,  for  example)  by  white 
labor  which  earns  the  normally  high  American  rates.  Here  the 
main  explanation  of  the  exports  must  be  found  in  the  effective- 
ness of  the  labor,  climatic  causes  being,  no  doubt,  important  in 
contributing  to  that  effectiveness. 

Clearer  illustration  of  the  influence  of  specially  low  wages  can 
be  found  elsewhere.  In  Saxony  and  Bavaria,  there  are  districts 
where  a  congested  population  is  willing  to  work  long  hours  for 
low  wages.  Toys,  and  some  sorts  of  textiles  and  knit  goods,  are 
turned  out  at  very  low  prices,  and  are  exported  in  considerable 
quantities.  In  England,  again,  while  most  exports  rest  on  effec- 
tiveness with  high  wages,  there  are  so-called  " parasitic"  in- 
dustries (lace  making  and  chain  making  are  examples)  in  which 
wages  are  especially  low,  and  in  which  prices  are  low  in  conse- 
quence. From  the  social  point  of  view,  these  are  not  welcome 
elements  in  a  country's  trade,  whether  domestic  or  foreign.  But 
so  far  as  the  currents  of  international  trade  are  concerned,  spe- 
cially low  wages  and  specially  productive  labor  operate  in  the 
same  direction, — both  promote  the  exports  of  the  commodities 
affected. 

The  effect  on  international  trade,  in  these  cases  of  low  wages, 
depends  on  their  being  limited  cases.  If  all  wages  in  a  country 
are  equally  low,  no  one  commodity  will  be  cheaper  than  any 
other,  and  no  effect  on  exports  or  imports  will  ensue.  On  this 
subject  there  is  a  sort  of  terror  among  many  persons  in  countries 
of  high  wages  like  the  United  States  and  England,  —  a  fear  of 
universal  underselling  and  wholesale  collapse,  because  wages  are 
lower  in  some  countries  from  which  exports  come.  The  relation 
between  international  trade  and  general  low  wages  deserves  a 
moment's  consideration. 

Suppose  two  countries,  —  say  the  United  States  and  Japan,  — 
suddenly  to  open  commercial  relations,  there  having  been  previ- 
ously no  trade  between  them.  Suppose  money  wages  to  be 


THE  THEORY  OF  INTERNATIONAL  TRADE          487 

lower  in  all  occupations  in  Japan,  and  all  goods  to  be  cheaper 
there.  Money  then  has  a  higher  value  in  that  country  than  in 
the  United  States ;  trade  in  merchandise  moves  one  way  only, 
goods  being  sent  to  the  United  States ;  specie  alone  flows  to 
Japan.  Prices  and  wages  will  then  rise  in  Japan,  and  will  fall 
in  the  United  States.  As  this  transition  goes  on  (doubtless  a 
trying  one,  especially  in  the  United  States) ,  the  flow  of  specie  will 
gradually  diminish,  and  will  finally  cease  when  equilibrium  has 
been  established.  But  that  equilibrium  will  not  necessarily  be 
reached  at  a  stage  of  equal  wages  in  both  countries ;  still  less  at 
a  stage  of  equal  prices  in  both,  and  consequent  cessation  of  all 
trade  between  them.  As  prices  in  general  move  up  in  Japan, 
in  response  to  the  inflow  of  specie,  it  will  appear  that  the  prices 
of  certain  commodities  do  not  move  up  to  the  American  prices  of 
the  same  commodities.  These  are  the  commodities  in  which^ 
Japanese  labor  is  effective,  or  (possibly)  in  which  some  sets  of 
Japanese  laborers  get  unusually  low  wages.  Such  commodities 
will  continue  to  be  exported  from  Japan  even  after  wages  and 
prices  in  general  have  risen.  Conversely,  in  the  United  States 
wages  and  prices  will  fall.  But  as  they  fall,  some  things  will 
prove  to  fall  in  price  below  the  Japanese  level.  These  are  the 
things  in  which  American  labor  has  an  advantage  or  (possibly) 
in  which  it  must  submit  to  specially  low  wages.  Such  things 
will  begin  to  be  exported  to  Japan  as  prices  there  rise,  and  they 
will  continue  to  be  steadily  exported.  In  other  words,  there  can 
hardly  be  such  a  thing  as  continued  underselling  in  all  goods. 
There  will  almost  certainly  be  an  equalization,  or  an  approach 
toward  equalization,  of  the  value  of  money  in  the  two  countries ; 
and  thereafter  a  development  of  imports  and  exports,  each 
country  exporting  those  things  in  which  it  has  an  advantage  and 
importing  those  in  which  it  has  a  disadvantage. 

No  such  extraordinary  case  has  ever  appeared.  The  adjust- 
ment of  relative  wages  and  prices  in  different  countries  has  taken 
place  by  a  gradual  and  almost  insensible  process.  Possibly 
something  like  an  abrupt  change  took  place,  in  Japan  in  the  last 
decades  of  the  nineteenth  century,  when  that  country,  previously 


488  INTERNATIONAL  TRADE 

sealed  to  foreigners,  was  opened  to  trade  with  them  and  entered 
on  her  amazing  political  and  industrial  transformation.  In 
virtually  all  cases,  the  main  lines  of  adjustment  were  settled  long 
ago.  And  this  general  adjustment,  it  should  be  noted,  has  by  no 
means  been  such  as  to  bring  about  an  equalization  of  money  in- 
comes or  of  general  prices ;  it  has  not  brought  about  a  uniform 
value  of  money  the  world  over.  In  the  supposed  trade  between 
the  United  States  and  Japan,  equilibrium  and  settled  exchange 
would  be  reached,  —  the  industrial  characteristics  of  the  two 
countries  being  as  they  now  are, — while  money  incomes  and 
most  prices  were  still  higher  in  the  United  States.  What  are  the 
causes  of  the  variations  in  money  incomes  and  in  general  prices 
between  country  and  country,  we  have  yet  to  consider.  But  it 
is  certain  that  they  do  not  lead  to  universal  underselling  or  to  a 
continued  trade  in  which  goods  move  one  way  only. 

§  4.  From  the  principle  of  comparative  costs,  it  follows  that  a 
country  may  fail  to  produce  things  which  it  can  produce  to  ad- 
vantage, —  may  import  things  in  which  its  labor  is  more  effec- 
tive than  is  labor  in  the  country  whence  they  come.  Not  all 
international  trade  rests  on  this  precise  relation ;  but  under  it 
the  peculiarities  of  international  trade  appear  most  markedly. 

If  a  country,  though  under  no  disadvantage  in  a  commodity, 
nay,  though  possessed  of  an  advantage  in  producing  it,  has  here  a 
less  advantage  than  in  other  commodities,  the  first  sort  will  be 
imported.  For  example,  labor  in  the  United  States  is  no  less 
productive  in  growing  hemp  than  labor  in  Italy  or  Russia ;  it  is 
probably  more  so ;  none  the  less,  hemp  is  imported  from  those 
countries.  Labor  in  this  country  is  no  less  productive  in  produc- 
ing flax  fiber  than  labor  in  Belgium,  or  in  making  linens  than  labor 
in  Germany  or  Ireland,  but  flax  and  linen  are  still  imported,  and 
this  in  face  of  a  considerable  duty  (hemp,  as  it  happens,  is  duty- 
free).  Coarse  wool,  such  as  is  used  in  making  carpets,  could  be 
grown  here  with  as  little  labor  as  in  China,  Asia  Minor,  Russia, 
and  sundry  other  backward  countries,  from  which,  none  the  less, 
it  is  steadily  imported.  The  everyday  explanation  of  all  these 
phenomena  is  that  labor  is  too  dear  in  the  United  States.  The 


THE  THEORY  OF  INTERNATIONAL  TRADE     489 

explanation  is  true  enough,  as  far  as  it  goes,  —  but  why  is  the 
labor  dear  ?  Our  high  rate  of  wages  does  riot  lead  to  the  impor- 
tation of  all  goods,  or  prevent  the  exportation  of  those  in  which 
the  productivity  of  labor  is  large.  High  general  wages  are  the  re- 
sults of  high  general  productivity.  Once  established  and  current, 
they  constitute  a  difficulty  for  other  possible  industries  in  which 
productivity  is  not  high.  The  real  explanation  of  the  continued 
importation  of  things  in  which  labor  is  at  no  disadvantage  is 
that  they  cannot  meet  the  pace  set  by  those  in  which  the  labor 
of  the  country  is  more  productively  applied. 

Obviously,  it  is  to  the  interest  of  a  country  to  turn  its  labor  into 
the  most  advantageous  channels ;  not  merely  to  those  industries 
in  which  it  is  at  no  disadvantage  or  has  only  a  slight  advantage, 
but  to  those  in  which  it  has  the  greatest  advantage.  Similarly, 
an  individual  finds  it  to  his  advantage  to  devote  himself,  once  for 
all,  to  that  occupation  in  which  he  is  most  proficient.  The  brick- 
layer does  not  carry  his  own  bricks,  even  though  he  could  carry 
as  many  as  the  hodcarrier,  perhaps  more.  He  can  lay  the  bricks 
immeasurably  better  than  the  hodcarrier,  and  gains  by  confin- 
ing himself  to  that.  An  able  business  man  delegates  to  clerks 
and  subordinates  much  routine  work,  even  work  involving  some 
responsibility  and  judgment,  which  he  could  do  better  himself ; 
he  confines  himself  to  the  still  more  difficult  tasks  of  manage- 
ment, in  which  he  has  peculiar  excellence. 

By  no  means  all  trade  between  countries,  or  all  division 
of  labor  between  individuals,  is  explicable  in  just  this  way.  Of- 
ten there  is  an  absolute  advantage  on  both  sides.  The  brick- 
layer may  be  skillful  without  being  physically  strong ;  the  hod- 
carrier  may  be  able  to  carry  more  bricks.  Each  can  do  his  own 
work  better  than  the  other.  The  capable  business  man  may 
not  be  able  to  do  clerical  work  as  well  as  his  bookkeeper.  A 
certain  impatience  and  abruptness  of  temper,  characteristic 
of  commanding  personalities,  may  unfit  him  for  monotonous 
office  work.  Similarly,  a  country  may  be  at  an  absolute  disad- 
vantage in  one  industry,  and  may  have  an  absolute  advantage 
in  another.  Such  is  the  relative  situation  of  temperate  and  of 


490  INTERNATIONAL  TRADE 

tropical  countries  as  regards  the  articles  they  commonly  ex- 
change with  each  other.  Brazil  produces  coffee  with  absolutely 
less  labor  than  the  United  States  could,  India  jute,  and  so  on; 
the  United  States  produces  wheat  and  makes  it  into  wheat  flour, 
spins  and  weaves  cotton  cloth,  with  less  labor  than  they  can. 

§  5.  There  is  a  difference  in  the  basis  of  the  gain  from  interna- 
tional trade,  and  in  its  probable  extent,  according  as  it  rests  on 
differences  merely  in  comparative  advantage,  or  on  absolute 
differences  of  the  sort  last  described.  In  the  second  case,  where 
each  country  has  a  clear  superiority,  exchange  between  them 
will  be  to  mutual  advantage  under  any  circumstances.  Though 
they  may  not  share  equally  in  the  gain  (of  this  more  will  be  said 
in  the  next  chapter),  it  will  be  to  their  interest  to  carry  on  the 
trade.  But  where  there  is  only  a  comparative  advantage,  the 
existence  of  the  trade,  and  the  gain  from  it,  rest  on  the  fact  that 
labor  does  not  move  freely  from  country  to  country.  Suppose, 
for  example,  that  labor  in  the  United  States  is  more  product! ve  all 
around  than  labor  in  Italy ;  it  will  be  none  the  less  to  the  advan- 
tage of  Americans  to  import  from  Italy  those  things  in  which, 
though  they  have  an  advantage,  it  is  a  less  advantage.  But  it 
would  also  be  to  the  interest  of  the  people  of  Italy  to  move  en 
masse  to  the  United  States.  Only  because  the  Italians  fail  to 
do  so,  and  prefer  to  remain  in  their  own  country,  will  that  trade 
be  carried  on  which  rests  simply  on  differences  in  comparative 
cost. 

The  indefinite  continuance  of  such  trade  thus  rests  on  immo- 
bility of  labor  between  countries, — on  the  ties  of  language,  na- 
tionality, religion,  on  the  obstacles  from  ignorance  and  poverty, 
which  hold  people  to  the  land  of  their  birth.  Great  as  is  the  emi- 
gration of  modern  times,  it  has  not  sufficed  to  put  an  end  to  this 
prevailing  immobility.  If,  in  the  example  just  given,  all  the 
Italians  were  to  move  to  the  United  States,  they  would  be  better 
off  than  before.  So  long  as  they  remain  at  home,  they  provide 
the  Americans  with  goods  more  cheaply  than  these  could  be  made 
in  the  United  States.  Once  in  the  United  States,  they  would 
indeed  produce  the  commodities  with  less  labor  than  before; 


THE  THEORY  OF  INTERNATIONAL  TRADE          491 

but  that  labor  would  have  to  be  paid  for  at  the  higher  American 
rate,  and  the  commodities  would  be  less  cheap.  The  Americans 
(let  us  say,  in  courtesy,  the  other  Americans)  would  be  less  well 
off.  It  is  conceivable,  to  be  sure,  that  when  the  Italians  got  to 
the  United  States,  they  would  not  receive  the  full  American  rate 
of  wages.  They  might  continue  to  work  for  the  Americans,  as 
they  had  done  in  Italy,  at  a  low  rate  of  wages.  And  it  is  true 
that  our  newly  arrived  immigrants,  in  fact,  are  in  a  group  by 
themselves.  But  their  pay  shows  at  least  some  approach  to  the 
American  rate.  Though  they  work  for  wages  not  up  to  the  level 
normal  in  the  United  States,  they  do  not  work  for  us  as  cheaply  as 
do  their  countrymen  who  remain  at  home.  It  happens,  also, 
that  often  they  do  not  work  at  the  identical  things  which  are 
imported  (or  under  free  trade  would  be  imported)  from  the  old 
countries.  These  things  it  continues  to  be  to  our  advantage  to 
procure  by  the  way  of  foreign  trade,  though  our  labor  may  be 
more  efficient  in  making  them  than  is  the  foreign  labor.  In  an 
ideal  —  and  we  might  call  it  Utopian  —  distribution  of  the 
world's  productive  forces,  the  division  of  labor  and  of  trade  which 
rests  solely  on  comparative  differences  in  costs  would  not 
exist.  But  as  men  and  nations  are,  no  small  part  is  played  by 
the  great  historical  gulfs  between  nations  and  races  and  by  the 
resulting  immobility  of  labor.1 

§  6.  From  the  preceding  exposition,  it  might  be  inferred  that 
a  country  produces  within  its  own  borders  no  articles  which  it 
imports,  and  that,  conversely,  whatever  articles  it  exports  are 
supplied  in  toto  to  the  other  country  or  countries.  But  this  does 
not  necessarily  follow.  More  especially  it  does  not  follow  with 
regard  to  the  considerable  range  of  commodities  which  are  pro- 
duced under  the  conditions  of  varying  costs  or  diminishing 
returns. 

Take  the  case  of  wheat,  which  the  United  States  exports  to 
England  and  Germany.  Some  wheat  can  be  grown  to  advan- 
tage in  these  countries,  —  a  great  deal  in  Germany,  less  in  humid 

1  This  topic  connects  itself  with  the  general  subject  of  differences  of  wages  and 
non-competing  groups ;  see  below,  Book  V,  Chapter  47,  especially  §§  5,  6. 


492  INTERNATIONAL  TRADE 

England.  They  are  at  a  comparative  disadvantage  only  when 
they  force  the  margin  of  cultivation  and  raise  wheat  on  the  land 
less  adapted  for  it.  On  the  better  sources  of  supply,  the  domestic 
producers  can  hold  their  own,  even  though  imports  come  in. 
Hence  the  national  supply  comes  partly  by  importation,  partly 
by  domestic  production.  The  same  is  the  case  in  the  United 
States  with  wool.  Some  parts  of  the  country  have  clear  advan- 
tages for  wool  growing,  and  are  adapted  for  little  else,  —  such 
as  the  semi-arid  plains  of  Montana.  Elsewhere  the  climate  is  not 
so  favorable,  or  (what  is  more  important)  the  land  can  more 
advantageously  be  put  to  other  uses.  Corn  and  wheat  pay 
better;  there  is  simply  a  comparative  disadvantage  in  wool 
growing.  The  total  supply  of  wool  which  the  country  wants  at 
current  prices  cannot  be  produced  in  those  regions  which  are 
advantageous  enough ;  hence  part  is  imported.  This  sort  of  im- 
portation —  wool  into  the  United  States,  wheat  into  Germany  — 
takes  place,  notwithstanding  duties  of  considerable  weight  on 
these  products  in  the  two  countries.  As  the  better  sources  of 
supply  in  each  country  have  been  fully  utilized,  it  has,become 
more  costly  to  procure  additional  wheat  and  wool;  hence,  as 
the  poorer  sources  are  resorted  to,  the  price  rises  until  imports 
come  in  over  the  duty.  Most  of  the  supply  in  each  country 
comes  from  domestic  production ;  but  there  is  a  steady  importa- 
tion. 

With  manufactured  goods  the  case  is  somewhat  different, 
since  there  are  not  commonly  the  same  limitations  set  by  nature 
to  the  increase  of  supply  at  constant  cost.  It  is  true  that  some 
division  of  the  field  is  likely  to  take  place  here  also.  Not  infre- 
quently there  are  permanent  causes  of  variation  of  cost  between 
different  establishments,  —  in  the  iron  manufacture,  for  ex- 
ample, as  to  supplies  of  ore  and  coal.  And  even  when  there  are 
not  such  deeply  rooted  causes  of  variation,  there  are  forces  of  a 
similar  sort  in  operation  for  considerable  periods.  The  principle 
of  constant  returns,  though  it  works  out  its  results  for  most  manu- 
factures in  the  long  run,  is  subject  to  great  modification  in  times 
of  rapid  change,  such  as  the  modern  world  has  seen  in  so  many 


493 

cases.1  At  any  one  time,  some  establishments  in  a  given  indus- 
try, say  the  woolen  manufacture,  may  have  such  advantages  as 
will  enable  them  to  hold  their  own  against  foreign  competition, 
and  others  may  not.  Part  of  the  supply,  but  not  all  of  it,  will 
be  got  by  importation. 

Nevertheless,  division  of  the  field  between  foreign  and  domes- 
tic manufacturers  is  less  common,  and  less  likely  to  persist, 
than  such  division  between  foreign  and  domestic  producers  in 
extractive  industries.  True,  it  happens  occasionally  that  there 
is  a  very  even  balance  between  the  two,  and  that  minor  factors, 
such  as  established  name  and  repute,  skill  in  satisfying  the  tastes 
and  whims  of  consumers,  will  determine  that  some  among  each 
set  of  producers  will  hold  their  own  in  the  market.  More  often, 
when  part  of  the  supply  of  a  manufactured  article,  and  part  only, 
is  recorded  as  coming  from  abroad,  it  will  be  found  that  the  im- 
ported article,  though  it  has  the  same  name  as  the  domestic,  is  of 
such  a  different  quality  as  to  be  virtually  a  different  thing. 
French  and  German  woolens  are  imported  into  England ;  but 
they  are  very  different  goods  from  those  which  the  English  make 
and  export.  The  same  explanation  of  an  apparently  anomalous 
phenomenon  (simultaneous  import  and  export  of  the  same  article) 
applies  to  some  raw  materials.  Though  the  United  States  is  a 
great  exporter  of  cotton,  she  imports  cotton  also ;  but  it  is  not 
the  same  as  is  exported.  What  comes  in  is  Egyptian  cotton,  of 
longer  fiber  than  the  ordinary  domestic,  used  for  certain  knit 
goods  and  other  fabrics. 

1  See  Book  III,  Chapter  12,  §  3,  and  Book  V,  Chapter  50,  $  2. 


CHAPTER  35 

THE  THEORY  OF  INTERNATIONAL  TRADE,  continued.    WHEREIN 
THE  GAIN  CONSISTS 

§  1.  In  the  preceding  chapter,  the  general  nature  of  the 
gain  from  international  trade,  and  the  causes  that  determine 
which  among  a  country's  commodities  will  be  exported,  have 
been  considered.  It  remains  to  examine  more  carefully  the 
nature  of  the  gain,  and  the  manner  in  which  it  is  shared  by  the 
trading  countries. 

For  this  phase  of  the  question,  it  will  be  best  to  turn  first 
to  the  case  where  each  country  has  an  absolute  advantage  in 
the  commodities  it  exports.  Such  is  the  nature  of  most  trade 
between  tropical  and  temperate  countries.  Such  also  is  the 
nature  of  most  trade  between  different  parts  of  the  same  country. 

Within  any  one  country  this  sort  of  geographical  division  of 
labor  does  not  commonly  give  rise  to  any  peculiar  problems. 
Exchange  takes  place  between  the  various  sections,  but  on  equal 
terms.  Within  a  country,  there  are  no  very  great  variations 
in  wages  and  incomes  —  for  persons  of  the  same  capacity  and 
skill  —  between  different  districts.  Yorkshire  is  a  great  woolen 
manufacturing  region,  Lancashire  is  a  great  cotton  goods  dis- 
trict; they  exchange  products;  but  wages  are  substantially 
the  same  in  the  two,  and  they  share  equally  in  the  advantages 
of  the  exchange.  Pennsylvania  produces  iron  and  coal,  the 
Mississippi  Valley  wheat  and  corn,  Oregon  lumber,  California 
fruits,  the  South  cotton,  New  England  sundry  manufactures. 
Though  there  is  no  complete  equalization  of  incomes  between 
different  parts  of  the  United  States,  we  find  in  the  country's 
general  industrial  conditions  an  unmistakable  homogeneity. 
Labor  flows  with  much  freedom  from  one  part  to  the  other 
(unless,  indeed,  it  be  kept  from  parts  of  the  South  by  the  race 

494 


WHEREIN  THE  GAIN  CONSISTS  495 

complication),  and  there  is  a  generally  high  level  of  money 
wages.  Not  only  is  the  geographical  division  of  labor  deter- 
mined in  the  main  by  obvious  advantages  in  production,  but 
the  people  of  all  the  parts  share  to  about  the  same  degree  in 
the  general  cheapness  and  abundance  which  it  promotes. 

But  between  tropical  and  temperate  countries,  and  between 
countries  civilized  and  those  half  civilized,  there  is  no  approach 
to  equalization  of  incomes.  India,  China,  Japan,  South  America, 
have  very  different  rates  of  wages  from  the  United  States  and 
Europe.  And  there  are  also  differences  between  the  United 
States  and  European  countries,  and  between  the  various 
European  countries.  Money  incomes  being  different,  the  gain 
from  international  trade  is  unequally  divided.  The  commodi- 
ties exchanged  are  at  the  same  price  (barring  cost  of  transpor- 
tation) in  the  .several  trading  countries.  The  English,  for 
example,  buy  woolen  goods  and  cotton  goods  and  coal,  as  well 
as  fruits  and  wines,  as  cheaply  as  the  Italians.  But  the  Eng- 
lish have  higher  money  incomes  with  which  to  purchase  both 
sets  of  commodities,  and  hence  benefit  more  from  the  trade 
with  Italy  than  the  Italians  do.  How  explain  these  differences  ? 

§  2.  Suppose  an  extreme  and  simple  case,  typified  by  Eng- 
land with  exports  of  coal,  Italy  with  exports  of  lemons ;  these 
exports  resulting  from  obvious  advantages  in  production  pos- 
sessed by  the  two  countries.  The  quantity  of  coal  which  Eng- 
land will  send  to  Italy  depends  on  the  conditions  of  demand 
in  that  country.  In  Italy  the  coal  will  sell  at  the  English  price, 
plus  cost  of  transportation,  and  at  this  price  a  certain  amount 
of  coal  can  be  disposed  of  there.  In  England,  on  the  other 
hand,  lemons  will  sell  at  the  Italian  price  plus  cost  of  trans- 
portation, and  at  this  price  a  certain  quantity  of  lemons  can 
be  disposed  of  in  England.  It  is  possible  that  the  two  amounts 
will  just  balance, — the  coal  exports  from  England  may  just 
equal  in  money  value  the  lemon  imports  into  England.  But 
if  we  suppose  the  two  countries  to  be  suddenly  brought  to  trade 
with  each  other,  no  previous  process  of  adjustment  having 
taken  place,  this  would  be  highly  improbable.  One  or  the 


496  INTERNATIONAL  TRADE 

other  sum  is  likely  to  be  the  greater.  Suppose  the  lemons 
exceed.  Then  Italy  will  export  to  England  more  (in  money 
value)  than  she  imports.  Specie  will  flow  to  Italy.  Prices 
will  rise  there,  and  money  incomes  will  rise  with  them.  Prices 
and  money  incomes,  on  the  other  hand,  will  fall  in  England. 
As  this  process  takes  place,  the  export  of  lemons  from  Italy 
will  be  checked;  for  lemons  rise  in  price  there  with  other 
things,  while  the  English  consumers  who  buy  them  have 
lessened  money  incomes.  But  exports  of  coal  from  England 
will  be  stimulated.  Prices  are  falling  in  that  country,  and 
the  price  of  coal  falls  with  other  things;  hence  coal  can  be 
sent  to  Italy  at  a  lower  price.  Its  consumption  in  Italy  is 
stimulated,  not  only  by  its  lower  price,  but  by  the  fact  that 
money  incomes  in  Italy  are  rising.  Eventually  a  stage  is 
reached  at  which  the  coal  just  pays  for  the  lemons.  The  im- 
ports equal  the  exports  in  money  value,  specie  no  longer  flows, 
equilibrium  is  established. 

Just  at  what  point  this  stage  is  reached  evidently  depends 
on  the  nature  of  the  demand  for  the  two  articles  in  the  trading 
countries.  If  the  demand  for  both  is  elastic,  equilibrium  will 
be  quickly  reached.  If  the  higher  price  of  lemons  quickly 
checks  the  English  consumption,  and  if  the  lower  price  of  coal 
quickly  stimulates  the  Italian  consumption,  the  money  values 
of  the  two  articles  will  soon  become  equal.  But  if  the  people 
of  England  have  a  strong  demand  —  that  is,  an  inelastic  de- 
mand —  for  lemons,  and  continue  to  use  very  nearly  the  same 
quantity  of  them,  even  though  their  price  rises  somewhat ;  and  if, 
on  the  other  hand,  the  people  of  Italy  have  an  inelastic  demand 
for  coal,  and  do  not  increase  their  use  of  it,  even  though  its 
price  becomes  lower,  —  then  a  long  process  of  changing  prices 
and  changing  incomes  will  ensue.  The  country  whose  demand 
is  great  for  the  products  of  the  other  country  will  have  com- 
paratively low  prices  and  low  money  incomes;  the  country 
whose  exports  are  in  insistent  demand  in  the  other  country 
will  have  comparatively  high  money  wages  and  money  incomes. 

The  case  supposed  (imaginary  in  that  it  assumes  these  two 


WHEREIN  THE  GAIN  CONSISTS  497 

articles  to  be  the  only  ones  exchanged  between  England  and 
Italy)  points  to  the  underlying  principle.  That  country  gains 
most  from  international  trade  whose  exports  are  most  in  de- 
mand, and  which  itself  has  little  demand  for  the  things  which 
it  imports,  —  that  is,  for  the  exports  of  other  countries.  That 
country  gains  least  which  has  the  most  insistent  demand  for 
the  products  of  other  countries.  In  the  semi-technical  terms 
which  we  have  used  elsewhere,  we  may  say  that  the  extent  to 
which  a  country  shares  in  the  gain  from  international  trade 
depends  on  the  marginal  utility  to  it  of  imported  goods  and  the 
marginal  utility  to  other  countries  of  its  exported  goods. 

This  cause  operates  through  that  mechanism  for  the  dis- 
tribution of  the  world's  stocks  of  specie,  and  that  equalization 
of  international  payments,  which  secures  the  general  equilib- 
rium of  exports  and  imports.  It  need  not  again  be  said  how 
slowly  these  forces  move,  how  difficult  it  is  to  follow  their 
operation  in  the  confused  currents  of  international  trade. 
The  imports  and  exports  of  the  various  nations  have  long 
accommodated  themselves  to  a  scheme  (if  that  word  can  be 
applied  to  something  which  has  grown  up  without  plan  or 
intent)  of  differences  in  the  value  of  money  in  the  various 
countries.  Though  changes  in  the  scheme  take  place,  they  come 
,by  slow  and  half-concealed  movements.  Many  economists  of 
modern  times,  intent  only  on  those  phenomena  which  are  un- 
mistakable and  susceptible  of  exact  observation,  ignore  the 
less  conspicuous  underlying  forces,  and  are  skeptical  concern- 
ing the  validity  of  fine-spun  theories  about  them.  Yet  the 
broad  phenomena  are  explicable  only  by  reasoning  of  this 
kind.  As  was  pointed  out  at  the  very  beginning  of  the  dis- 
cussion of  international  trade,  it  is  obvious  that  great  differ- 
ences in  money  incomes  exist  between  the  various  countries, 
and  that  they  persist  through  very  long  periods.  It  is  obvious, 
too,  that  these  differences  bring  inequalities  in  the  gains  from 
foreign  trade.  The  flow  of  specie,  again,  is  governed  by  the 
prices  and  the  consumption  of  the  articles  that  enter  into 
foreign  trade.  Notwithstanding  that  flow,  the  value  of  money 

2K 


498  INTERNATIONAL  TRADE 

is  not  brought  to  the  same  level  the  world  over ;  and  notwith- 
standing the  variations  in  the  money  incomes  and  prices,  sub- 
stantial equilibrium  in  payments  between  the  countries  is  still 
reached.  All  these  phenomena  are  brought  into  orderly  con- 
nection by  the  theory  of  reciprocal  demand. 

§  3.  Suppose  now  another  case,  nearer  to  reality.  Suppose 
that,  between  countries  whose  trade  has  previously  come  to 
equilibrium,  a  change  in  demand  sets  in;  that  England,  for 
example,  having  imported  from  the  United  States  as  much  as 
her  exports  paid  for,  now  demands  more  of  American  goods. 
Stated  more  accurately,  the  supposition  is  that  English  con- 
sumers buy,  at  ruling  prices,  more  of  the  American  goods  — 
cotton,  wheat,  kerosene,  or  what  not  —  than  they  bought 
before.  Specie  then  must  flow  from  England  to  the  United 
States;  or,  what  amounts  in  effect  to  the  same  thing,  new 
specie  from  the  mines,  which  would  otherwise  have  gone  to 
England,  must  be  diverted  to  the  United  States.  If  this  move- 
ment takes  place  on  a  considerable  scale  and  for  a  considerable 
time,  it  must  affect  prices.  The  same  train  of  consequences 
will  ensue  as  in  the  supposed  trade  between  England  and 
Italy.  Prices  and  money  incomes  will  rise  in  the  United 
States,  and  will  fall  in  England.  Eventually  these  shifts  will 
again  bring  equilibrium.  The  higher  American  prices  will 
check  the  increase  of  exports  from  the  United  States,  the  lower 
English  prices  will  stimulate  an  increase  of  exports  from  Eng- 
land. Money  incomes  will  reach  a  somewhat  higher  level  in 
the  United  States,  a  somewhat  lower  level  in  England.  As 
consumers  of  English  goods,  the  Americans  will  gain ;  as  con- 
sumers of  American  goods,  the  English  will  lose.  Thus  the 
increase  in  English  demand  for  American  goods  will  cause  the 
English  to  gain  less  from  the  trade  between  the  countries,  the 
Americans  to  gain  more. 

Again,  the  appearance  of  a  new  article  of  export  in  a  coun- 
try's foreign  trade  operates  in  the  same  way.  Kerosene  oil  has 
become  an  important  article  of  export  from  the  United  States 
during  the  last  forty  years  (since  1870),  —  a  clear  addition 


WHEREIN  THE  GAIN  CONSISTS  499 

to  the  things  which  foreign  consumers  have  bought.  This  had 
to  be  paid  for.  If  trade  before  was  at  equilibrium,  and  if  no 
other  disturbing  factor  entered,  specie  must  have  been  diverted 
to  the  United  States,  as  in  the  case  previously  supposed.  The 
same  consequences  must  have  followed,  until,  by  a  gradual 
stimulus  to  foreign  imports  into  the  United  States,  anq1  by  a 
gradual  check  to  exports  (other  than  the  new  article)  from  the 
United  States,  equilibrium  was  reestablished,  with  a  new  scale 
of  prices  in  the  two  countries.  The  foreign  countries  indeed 
gain  by  having  the  new  article  which  they  did  not  have  before. 
But  they  lose  by  having  to  pay  somewhat  higher  prices  for 
other  American  articles,  and  by  having  somewhat  lower  money 
incomes  with  which  to  pay  for  them. 

An  obligation  to  make  other  payments  than  those  for  mer- 
chandise has  corresponding  effects.  If  a  country  has  remit- 
tances to  make  to  other  countries,  —  whether  for  travelers' 
expenses,  absentees,  interest  on  accumulated  debt,  freight 
charges,  or  the  like  debit  items  —  it  is  likely  to  be  in  a  worse  posi- 
tion as  regards  the  gain  from  its  trade  with  the  other  countries. 
The  remittances  must  be  made  in  money,  or  in  money's  worth. 
They  must  be  made  in  the  first  instance  —  international  pay- 
ments having  previously  balanced  —  by  an  outflow  of  specie. 
That  outflow  of  specie  lowers  prices ;  it  stimulates  exports  and 
checks  imports.  In  the  end  the  payments  are  effected  by  an 
excess  of  merchandise  exports.  But  the  process  which  brings 
these  added  exports  brings  also  lower  prices  and  lower  money 
incomes  in  the  remitting  country,  and  so  lessened  advantage 
from  international  trade.  The  need  of  forcing  more  exports 
on  the  foreign  consumers  causes  the  foreigners  to  get  the  ex- 
ports on  better  terms,  and  causes  domestic  consumers  to  get 
the  foreign  imports  on  worse  terms. 

§  4.  It  is  extremely  difficult  to  follow  these  forces  in  any 
concrete  case ;  for  it  is  rare  that  any  one  factor  operates  alone, 
even  rare  that  several  factors  combine  to  operate  in  the  same 
direction.  Nowhere  is  this  difficulty  better  illustrated  than 
in  the  experience  of  the  United  States  during  the  last  thirty  or 


500  INTERNATIONAL  TRADE 

forty  years.  The  play  of  international  demand  works  out  its 
results  over  long  periods, — it  is  only  thus  that  the  flow  of  specie 
affects  prices.  But  during  the  period  mentioned,  say  since 
1873,  a  multitude  of  conflicting  forces  have  been  at  work. 
We  have  seen  that  since  that  year  the  foreign  trade  of  the 
United  States  in  one  respect  has  clearly  taken  a  new  turn: 
the  merchandise  exports,  which  previously  were  less  than  the 
imports,  have  come  to  exceed  the  imports.1  The  change  is 
explained  by  the  various  additional  payments  (for  interest, 
travelers'  expenses,  immigrants'  remittances,  freight  charges, 
and  so  on)  which  Americans  have  to  make  to  foreigners.  This 
circumstance  per  se  would  tend  to  cause  an  outflow  of  specie, 
to  lower  prices  and  incomes,  to  make  the  terms  of  international 
exchange  less  favorable.  But  during  the  same  period  (since 
1873)  a  great  increase  in  the  demand  for  American  exports  has 
set  in,  —  for  our  cotton,  wheat,  meat  products,  and  for  some 
manufactures;  while  new  articles  of  export,  such  as  kerosene 
and  copper,  have  become  important.  All  this  has  worked  in 
just  the  contrary  direction.  During  the  same  period,  more- 
over, a  policy  of  protective  import  duties  has  been  applied  with 
great  rigor;  and  such  a  policy  also,  as  will  appear  presently,2 
operates  in  the  same  favorable  direction.  Meanwhile  gold  has 
been  mined  on  a  large  scale  within  the  country.  Legislation 
also  has  been  an  important  factor  in  the  country's  monetary 
supply  :  consider  the  resumption  of  specie  payments,  the  in- 
jection of  silver  money  from  the  acts  of  1878  and  1890,  the 
peculiar  working  of  the  national  bank  system.  Throughout 
the  period  there  has  been  great  growth  of  population  and 
wealth,  and  therefore  a  great  increase  in  the  demand  for  money, 
—  an  increase  which,  taken  by  itself,  would  tend  to  lower  prices. 
What  a  jumble  of  interacting  and  conflicting  elements  !  How 
say  whether  the  forces  that  made  for  greater  gain  from  for- 
eign trade  outweighed  those  that  made  for  less  gain?  How 
follow  in  detail  the  concrete  working  of  any  one  factor?  The 
difficulty  would  probably  be  the  same  in  kind,  though  less  in 

1  See  above,  Chapter  33,  §  4.  *  See  below,  Chapter  37,  §  1. 


WHEREIN  THE  GAIN  CONSISTS  601 

degree,  if  an  examination  were  attempted  of  the  foreign  trade 
over  a  considerable  period  of  any  European  country. 

The  difficulty  is  one  common  in  economics.  A  number  of 
forces  combine  —  acting  sometimes  in  the  same  direction, 
sometimes  in  conflict  with  each  other  —  to  bring  about  a  gross 
result.  Being  necessarily  debarred  from  deliberate  experiment, 
we  must  resort  to  hypothetical  reasoning,  and  must  be  content 
with  general  conclusions  confirmed  only  in  part  by  direct  ex- 
perience. Thus,  we  reason  that  an  increase  in  the  money  supply 
must  raise  prices.  We  find  that  in  the  long  run,  and  making 
due  allowance  for  credit  fluctuations,  for  bank  reserves  and 
bank  expansion,  this  is  true;  and  the  result  is  further  con- 
firmed by  the  striking  phenomena  of  paper  money  inflation. 
We  reason  that  a  flow  of  specie  from  one  country  to  another 
tends  automatically  to  bring  its  own  check,  and  that  payments 
between  countries  tend  to  balance  without  the  movement  of 
specie.  We  find,  in  fact,  that  payments  are  usually  adjusted 
with  a  very  small  use  of  specie;  while  those  cases  in  which  it 
moves  steadily  one  way — from  specie-mining  countries,  for 
example,  or  from  western  countries  to  the  sluggish  communities 
of  the  East — are  exceptions  of  the  sort  that  confirm  the  rule; 
they  are  explicable  on  grounds  of  their  own.  We  reason  that 
the  stage  of  equilibrium  in  payments  is  reached  by  a  process 
which  involves  in  the  several  countries  different  levels  of  money 
incomes  and  prices;  and  we  find  that  in  fact  some  countries 
have  markedly  higher  wages  and  prices  than  others.  All  these 
verifications  of  the  general  reasoning  give  us  confidence  in 
phases  of  the  reasoning  which  we  cannot  verify  directly.  Among 
the  conclusions  verified  in  this  indirect  way  is  that  reached 
in  the  preceding  discussion :  a  country's  share  in  the  gains 
from  international  trade  depends  on  the  play  of  reciprocal 
demand.  The  more  insistent  is  the  demand  for  a  country's 
products  in  other  countries,  and  the  less  insistent  is  its  own 
demand  for  the  products  of  other  countries,  the  greater  then  is 
its  gain  from  international  trade. 

§  5.   The  rise  and  fall  of  money  incomes  and  of  prices,  in 


502  INTERNATIONAL  TRADE 

relation  to  international  trade,  call  for  some  further  discussion. 
Strictly  speaking,  it  is  not  the  rise  or  the  fall  of  prices,  but 
that  of  money  incomes  alone,  which  is  of  consequence. 

Differences  in  the  value  of  money  —  in  the  general  level  of 
prices  and  incomes  —  which  result  from  the  play  of  inter- 
national demand,  are  of  real  and  permanent  importance  only 
with  reference  to  foreign  goods.  A  general  rise  of  prices  and 
incomes  is  in  the  long  run  immaterial ;  it  means  only  the  use 
of  more  counters  in  exchange.  It  is  true  that  the  process  of 
transition  disturbs  the  relations  of  debtors  and  creditors ;  per- 
haps true,  also,  that  rising  prices  bring  a  certain  stimulus  to 
production.1  But  these  are  transitory  effects.  It  is  obvious 
that  in  the  end  people  are  no  better  off  from  having  higher 
money  incomes,  if  prices  rise  to  the  same  extent.  And  domestic 
prices  will  rise,  under  the  influence  of  changed  conditions  of 
international  trade  and  inflow  of  specie,  as  much  as  wages  and 
other  incomes.  But  prices  of  foreign  (imported)  goods  are 
differently  affected  by  these  same  conditions.  They  do  not 
rise ;  they  fall.  The  higher  incomes  go  further  in  the  purchase 
of  foreign  goods,  and  in  these  purchases  only.  Conversely,  a 
fall  in  incomes  and  prices,  due  to  changes  in  international 
trade  working  in  the  opposite  direction,  affects  consumers  only 
in  their  purchases  of  imported  things.  As  for  domestic  com- 
modities, the  fall  in  money  incomes  is  offset  by  the  fall  in 
their  prices.  But  foreign  goods  tend  to  become  dearer,  and  in 
buying  these  there  is  a  real  loss. 

Changes  in  the  value  of  money,  due  to  varying  currents  of 
international  trade,  thus  bring  about  not  only  transitional  effects 
(such  as  those  on  debtors  and  creditors),  but  permanent  effects 
as  well.  But  these  permanent  effects  are  of  a  different  sort  from 
what  is  implied  by  the  phrases  commonly  used.  They  do  not 
arise  from  the  fact  that  increased  exports  bring  in  more  money. 
They  arise  because  foreign  goods  are  secured  on  easier  terms.  An 
increase  in  the  monetary  supply,  equally  distributed  over  all  the 
world,  would  benefit  no  one.  But  an  increase  which  went  to  one 

1  Compare  what  has  been  said  in  Book  III,  Chapter  22,  §§  6,  7. 


WHEREIN  THE  GAIN  CONSISTS  503 

country  alone,  or  which  went  in  larger  proportion  to  one  coun- 
try than  to  others,  would  benefit  the  people  of  that  country  in 
their  dealings  with  other  peoples.  And  similarly  a  redistribution 
of  the  existing  supplies,  due  to  changed  conditions  of  demand  in 
the  trade  between  the  different  countries,  would  cause  the  people 
of  some  to  secure  greater  gains  from  their  dealings  with  others. 

One  application  of  this  reasoning  is  obvious.  A  country 
gets  its  gain  from  international  trade  only  if  it  takes  advantage  of 
the  relative  cheapness  of  foreign  goods.  So  long  as  these  are 
admitted  free  of  duty,  and  only  so  long,  does  it  secure  in  full  the 
real  advantage  from  high  money  incomes,  or  from  a  rise  in  money 
incomes.  Duties  imposed  on  foreign  goods  simply  cut  off  that 
advantage.  And  if  the  duties  operate  to  bring  about  the  pro- 
duction within  the  country  of  goods  which,  without  the  duties, 
would  be  imported,  the  gain  from  foreign  trade  entirely  disap- 
pears. Such,  in  brief,  is  the  main  argument  in  favor  of  free  trade ; 
and,  as  far  as  it  goes,  it  is  unanswerable.  This  is  by  no  means  all 
that  is  to  be  said  on  the  controversy  between  free  traders  and 
protectionists,  but  it  is  a  fundamental  truth,  much  befogged  by 
current  fallacies,  yet  not  to  be  mistaken  by  any  one  who  has 
grasped  the  principles  of  division  of  labor,  exchange,  money,  and 
prices. 

§  6.  The  extent  of  a  country's  gain  from  international  trade 
depends  on  two  causes  :  first,  the  terms  of  international  exchange 
as  just  explained ;  second,  the  efficiency  of  its  labor  in  producing 
exported  commodities.  Both  causes  contribute  in  bringing 
about  a  high  or  a  low  range  of  money  incomes,  as  the  case  may 
be,  and  so  a  greater  or  a  less  gain  from  the  purchase  of  foreign 
commodities. 

The  action  of  the  two  causes  is  illustrated  by  the  different 
positions  of  the  United  States  and  Russia  as  exporters  of  wheat. 
The  wheat  growers  in  both  countries  sell  their  product  at  the 
same  price  in  the  world's  markets.  So  far  as  the  play  of  interna- 
tional demand  goes,  both  gain  to  the  same  extent.  But  so  far 
as  the  cost  of  producing  wheat  goes,  —  that  is,  the  real  cost, 
measured  by  the  amount  of  labor  needed  for  producing  it,  — • 


504  INTERNATIONAL  TRADE 

they  are  in  very  different  positions.  Wheat  is  grown  with  much 
less  labor  in  the  United  States,  and  money  wages  are  higher  here. 
Money  wages  are  lower  in  Russia,  and  the  wheat  growers  of  Rus- 
sia, as  indeed  all  Russians,  are  by  so  much  in  a  less  advantageous 
position  in  buying  foreign  goods.  As  between  any  two  or  more 
countries  competing  in  the  sale  of  the  same  article,  the  extent  of 
their  several  gains  from  international  trade  depends  on  the  rela- 
tive efficiency  of  their  labor  in  producing  the  things  exported. 

The  determining  cause  of  the  general  rate  of  money  incomes 
and  wages  in  a  country  is  to  be  found  in  the  exporting  in- 
dustries. These  set  the  pace ;  not  for  real  wages,  but  for  money 
wages.  Whatever  is  yielded  by  them  tends  to  become, 
under  the  influence  of  competition,  the  ruling  rate  in  the 
country  at  large,  —  in  other  industries,  as  well  as  in  those 
exporting.  In  the  other  industries,  this  money  rate  is,  to  be 
sure,  a  matter  of  comparative  indifference,  since  the  prices 
of  commodities  will  rise  and  fall  with  the  rise  and  fall  of  wages 
and  incomes.  The  same  parallel  movement  appears  in  the  ex- 
porting industries, — the  prices  of  exported  commodities  go  up 
and  down  with  the  money  wages  of  the  laborers  engaged  in  pro- 
ducing them.  In  fact,  these  money  wages  are  derived  from  the 
prices  at  which  the  exported  commodities  are  disposed  of  in  the 
world's  markets.  The  parallel  movement  does  not  appear  in 
the  case  of  imported  goods ;  the  real  gain  from  higher  money 
incomes,  as  has  been  sufficiently  explained,  is  secured  from  the' 
lower  prices  of  articles  of  import. 

§  7.  A  further  question  arises,  in  regard  to  which  also  there  is 
much  misconception.  Is  a  country  of  higher  money  incomes  — 
that  is,  one  with  advantageous  terms  of  international  trade  — 
also  a  country  of  higher  prices  ?  Most  persons  would  answer  the 
question  in  the  affirmative.  But  no  unqualified  answer  can 
be  given.  It  depends. 

Commodities  may  be  divided  roughly  into  two  classes  :  those 
which  do  enter  into  foreign  trade,  and  those  which  do  not.  The 
former  we  may  call,  for  brevity,  export  commodities ;  the  latter 
we  may  call  domestic  commodities.  Under  conditions  of  free 


WHEREIN  THE  GAIN  CONSISTS  505 

exchange,  and  with  due  allowance  for  the  expense  of  trans- 
portation, export  commodities  tend  to  be  at  the  same  price  the 
world  over.  Domestic  commodities,  however,  may  be  at  vary- 
ing prices  in  different  countries.  The  range  of  domestic 
commodities  remains  wide,  notwithstanding  the  cheapening  of 
transportation  and  the  consequent  extension  of  international 
trade  and  international  competition.  Many  things  are  too  bulky, 
in  proportion  to  their  value,  to  be  moved  far  from  the  place  of 
production ;  such  are  brick  and  stone.  Some  are  so  much  affected 
by  rooted  habit  that  only  the  near-by  producers  can  fashion 
them  in  the  way  desired  by  consumers ;  such  are  articles  of  house- 
hold furniture.  Some  are  of  necessity  made  on  the  spot  where 
they  are  used ;  house  accommodation  is  an  obvious  case.  The 
services  of  physicians,  lawyers,  actors,  musicians,  domestic 
servants  are  also  necessarily  rendered  on  the  spot.  These  utili- 
ties are  of  no  small  importance,  especially  for  the  well-to-do; 
their  price  evidently  is  determined  by  domestic  conditions  alone. 
Consider  now  such  an  item  as  household  furniture,  tables, 
chairs,  bedsteads,  chests.  Will  these  be  dearer  in  the  United 
States,  a  country  of  high  money  incomes,  than  in  Germany, 
a  country  of  comparatively  low  money  incomes  ?  The  answer 
depends  on  the  effectiveness  of  American  labor  in  producing 
them.  If  American  labor  is  relatively  as  effective  in  this 
field  as  it  is  in  export  commodities,  they  will  not  be  dearer. 
We  have  seen  that  American  labor  is  more  effective  than 
German  labor  as  regards  wheat;  otherwise,  wheat  could  not 
be  cheaper  in  the  United  States,  and  could  not  be  sent  thence  to 
Germany.  But  American  labor  may  also  be  more  effective 
than  German  as  regards  tables  and  chairs ;  and  then  tables  and 
chairs,  though  the  laborers  who  make  them  get  higher  wages,  will 
not  be  dearer  in  the  United  States.  The  principle  is  simple: 
those  domestic  commodities  as  to  which  a  country's  labor  has 
the  same  degree  of  effectiveness  as  it  has  in  making  exported 
articles,  will  be  relatively  cheap,  just  as  the  exported  commodi- 
ties are  relatively  cheap.  Those  domestic  commodities  in  which 
there  is  no  such  advantage  will  be  dearer,  and  will  be  dearer  to 


506  INTERNATIONAL  TRADE 

the  degree  in  which  the  effectiveness  of  labor  is  less.  The  reader 
can  supply  for  himself  the  extension  of  the  argument  which 
comes  from  the  fact  that  some  labor  in  a  country,  though  not 
effective,  is  paid  at  an  unusually  low  rate.  Domestic  commod- 
ities made  by  such  unfortunate  laborers  will  also  be  cheap. 

There  is  a  common  impression  that  the  United  States,  a  coun- 
try of  high  money  incomes,  is  also  a  country  of  high  prices.  But 
this  impression  rests  on  no  certain  basis.  It  is  probably  due  to 
the  fact  that  many  things  are  really  dearer  for  the  well-to-do. 
Services  are  almost  necessarily  dearer  in  the  country  of  high  in- 
comes. Domestic  servants,  for  example,  get  higher  wages  than 
in  Europe.  Physicians  and  lawyers  get  higher  fees,  teachers 
higher  salaries.  There  are  many  things  in  which  personal  serv- 
ice, while  not  the  sole  element,  is  yet  by  far  the  most  important ; 
such  are  cab  service  and  hotel  accommodation.  A  great  part  of 
the  income  of  the  prosperous  classes  is  spent  on  various  forms  of 
personal  service,  and  for  these  classes  the  "expense  of  livkig" 
(which  means  the  expense  of  a  given  conventional  mode  of  life) 
is  high.  Therefore,  those  among  them  who  have  fixed  incomes 
find  that  their  incomes  go  farther  if  they  live  abroad ;  hence 
their  impression  that  all  things  are  cheaper  abroad.  But  many 
domestic  commodities  of  general  consumption  among  all  classes 
are  probably  not  dearer.  Most  food  is  equally  cheap,  —  not 
only  that  which  enters  into  foreign  trade,  but  that  which  is 
solely  used  at  home.  Fuel  is  as  cheap  in  the  greater  part  of  the 
country,  though  not  on  the  Atlantic  seaboard,  where  the  expen- 
sive anthracite  is  used.  As  to  the  important  item  of  house  ac- 
commodation (indicated  by  house  rent)  it  is  not  easy  to  make  a 
comparison,  because  of  the  difficulty  of  making  allowance  for 
quality.  I  suspect  that,  taking  into  account  size,  convenience, 
and  attractiveness,  prices  are  not  higher  in  most  parts  of  the 
United  States  for  the  housing  accommodations  of  the  masses  ; 
though  they  doubtless  are  so  for  the  rich,  whose  houses  are  built 
" by  the  day"  and  with  little  use  of  factory-made  frames,  doors, 
and  windows.  Clothing,  and  especially  woolen  clothing,  is 
dearer, — a  result  due  mainly  to  our  policy  of  high  import  duties, 


WHEREIN  THE  GAIN  CONSISTS  507 

which  prevent  us  from  using  our  high  money  incomes  to  advan- 
tage in  the  purchase  of  cheaper  foreign  woolens.1 

1  In  this  chapter  and  in  that  preceding,  it  has  been  tacitly  assumed  that 
within  a  country  (so  far  as  domestic  commodities  are  concerned)  exchange  takes 
place,  and  value  is  determined,  on  the  basis  of  labor  cost,  —  that  value  rests  on 
"cost  of  production,"  not  on  "expenses  of  production."  Elsewhere,  however, 
it  has  been  assumed  that  supply  price,  in  its  relation  to  value,  means  expenses 
of  production,  not  cost  (see  Book  II,  Chapter  12,  §  1).  The  explanation  of 
the  inconsistency,  and  the  grounds  for  considering  it  not  repugnant  to  the  gen- 
eral validity  of  the  reasoning  upon  international  trade,  must  be  left  for  later 
discussion.  See  Book  V,  Chapters  47  and  48,  and  especially  §  5  of  Chapter  48, 
for  the  further  consideration  of  this  difficult  subject. 


CHAPTER  36 

PROTECTION  AND  FREE  TRADE.    THE  CASE  FOR  FREE  TRADE 

§  1.  The  main  argument  in  favor  of  free  trade  between  na- 
tions has  been  already  indicated.  It  is  a  simple  corollary  from 
the  principles  of  the  division  of  labor.  Exchange  between  indi- 
viduals brings  the  same  gain  whether  they  live  in  the  same 
village  or  in  widely  separated  districts.  Things  are  obtained  by 
the  exchange  more  easily  and  abundantly  than  they  could  be 
obtained  by  each  person's  producing  for  himself.  The  reasoning 
which  shows  that  it  is  advantageous  for  the  farmer  to  deal  with 
the  village  blacksmith,  for  Maine  to  deal  with  Florida,  for  New 
England  with  the  Mississippi  Valley,  makes  out  a  strong  prima 
facie  case  in  favor  of  free  exchange  between  the  United  States 
and  England,  between  France  and  Germany.  The  burden  of 
proof  may  be  fairly  said  to  rest  on  those  who  assert  there  is  gain 
from  the  contrary  policy. 

Most  of  the  common  arguments  in  favor  of  restrictions  upon 
trade,  by  protective  duties  or  otherwise,  are  fallacious.  Many 
are  crudely  Mercantilistic,  resting  on  an  assumption  that  im- 
ports are  bad  per  se  and  exports  good.  The  so-called  unfavor- 
able balance  of  trade  is  made  much  of.  What  is  expended  on 
imports  is  deemed  so  much  wasted  or  lost.  It  is  supposed  that 
a  decline  in  imports  or  an  increase  of  exports  necessarily  brings 
money  into  the  country;  and  the  notion  persists  that  herein 
there  is  a  gain,  which  comes  directly  from  the  balance  of  money 
secured,  not  through  those  effects  on  money  incomes  and  foreign 
prices  which  were  analyzed  in  the  preceding  chapter.  Few 
among  those  who  speak  of  a  gain  in  exports  as  profitable  ever 
heard  of  the  last-named  process  or  are  able,  unprepared,  to  un- 
derstand it.  They  think  of  exports  as  bringing  in  money,  and 
imports  as  taking  money  out,  and  money  is  the  be-all  and 

508 


PROTECTION  AND  FREE  TRADE  509 

end-all  of  their  economic  thinking.  Even  if  it  is  pointed  out 
that  a  continuing  excess  of  exports  is  due  simply  to  other  than 
merchandise  transactions,  and  does  not  bring  in  specie,  the 
notion  still  persists  that  exports  somehow  mean  gain  and  im- 
ports loss.  The  elementary  truth  that  exports  are  but  a  means 
of  procuring  the  imports  on  easier  terms  than  the  same  goods 
could  be  got  by  making  them  at  home,  —  this  is  rarely  grasped, 
or,  if  once  grasped,  is  soon  let  slip. 

Mercantilist  notions,  universally  discarded  though  they  are  by 
the  well-informed,  affect  the  policy  of  nations,  not  only  by 
strengthening  the  movement  toward  protection,  but  in  other 
ways  also.  The  public  railways  of  Prussia  and  of  other  German 
states  make  special  rates  for  exported  goods,  on  the  theory  that 
this  sort  of  movement  deserves  especially  to  be  fostered.  Ship- 
ping subsidies  are  granted  by  many  countries,  and  colonies 
acquired  and  maintained  at  great  expense,  with  the  same  object 
in  view.  The  United  States  government  spends  considerable 
sums  in  gathering  information  about  opportunities  for  export, 
and  in  promoting  otherwise  the  export  market;  while  various 
semi-public  agencies  and  museums  cooperate  for  this  supposedly 
praiseworthy  object.  Underlying  almost  all  activity  of  this  sort 
is  the  persistent  belief  that  there  is  something  peculiarly  profitable 
in  international  trade,  and  that  the  profit  appears  in  the  sale  of 
the  exports, — a  belief  which  exaggerates  the  importance  of  the 
trade,  and  misconceives  the  nature  of  the  real  gain  from  it. 

Perhaps  the  ancient  association  of  foreigner  with  enemy  still 
lingers.  People  do  not  worry  when  New  England  buys  coal  from 
Pennsylvania ;  but  when  coal  is  bought  from  Nova  Scotia,  dire 
consequences  are  supposed  to  ensue.  Half  a  century  ago  (more 
or  less)  the  region  which  is  now  British  Columbia  was  claimed  by 
the  United  States  to  be  part  of  its  territory.  Had  the  Oregon 
question  been  settled  at  that  time  in  accord  with  the  American 
claims,  no  one  would  have  questioned  that  the  resources  of 
British  Columbia  in  lumber,  coal,  and  fisheries  were  of  advantage 
to  Americans.  But  once  a  border  line  is  drawn,  the  situation  is 
supposed  to  change ;  and  that  which  would  have  brought  us 


510  INTERNATIONAL  TRADE 

gain  in  the  way  of  more  abundant  and  cheaper  supplies  is 
fraught  with  peril  precisely  because  these  supplies  came  from  a 
foreigner. 

§  2.  Some  of  the  popular  arguments  in  favor  of  protection  call 
for  brief  consideration ;  .for  example,  that  it  creates  a  home  mar- 
ket; that  it  makes  employment;  and  that  it  raises  wages  or 
keeps  them  high. 

When  imports  are  checked,  and  the  things  previously  im- 
ported are  made  at  home,  a  home  market  is  supposed  to  be  cre- 
ated. It  is  created ;  but  there  is  not,  as  protectionists  commonly 
state  or  imply,  an  additional  market.  Another  and  different 
market  is  substituted.  Here  again  most  people's  ideas  do  not  get 
beyond  the  range  of  sales  and  of  money  dealings.  When  the  linen 
manufacture  (say)  is  established,  those  engaged  in  it  buy  food 
and  other  supplies;  and  here,  it  is  supposed,  is  an  additional 
market  for  food.  The  real  "market"-— that  is,  the  real  ex- 
change —  is  of  food  for  linens.  That  same  market  existed 
when  linens  were  imported,  and  food  or  other  things  were  ex- 
ported in  payment.  To  cut  off  imports  means  to  cut  off  exports 
also;  it  means  simply  the  substitution  of  exchange  within  the 
country  for  exchange  between  countries.  The  real  question  is 
whether  for  a  given  quantity  of  food  (i.e.  of  labor  exerted  in  pro- 
ducing that  quantity)  more  linen  is  got  in  one  way  than  in  the 
other.  The  very  fact  that  linen  can  be  got  cheaper  by  importa- 
tion shows  prima  facie  that  the  foreign  market  is  better  than  the 
domestic  market.  The  home  market  argument  is  most  fre- 
quently used  in  the  United  States  with  reference  to  the  farmers, 
who  are  supposed  to  get  benefit  from  a  greater  demand  for  their 
products  because  of  the  establishment  of  manufactures.  The 
presumption  is,  however,  that  they  do  not  gain,  but  lose ;  the 
"market "  which  is  created  offers  less  in  exchange  for  their  prod- 
ucts than  does  the  foreign  market. 

A  special  form  of  the  home  market  argument,  also  much  used 
in  the  United  States,  is  suggested  by  the  truck  farm.  Suppose 
a  manufacturing  town  is  established  in  consequence  of  protec- 
tion :  the  near-by  farmers  profit  by  the  sale  of  milk,  vegetables, 


PROTECTION  AND  FREE  TRADE  511 

and  the  like.  These  farmers  do  in  fact  profit,  but  simply 
because,  while  they  sell  all  their  produce  in  the  town,  they 
purchase  a  very  small  share,  if  any,  of  the  particular  things 
which  are  made  in  it.  If  they  had  previously  exported  all  their 
vegetables  and  dairy  products,  and  if  the  manufacturing  town, 
after  the  duty,  supplied  precisely  the  goods  which  they  had  pre- 
viously procured  by  importation,  they  would  lose,  not  gain. 
The  truck  farmers,  in  truth,  are  ordinarily  within  the  limited 
circle  of  real  beneficiaries  from  protection.  They  gain,  how- 
ever, not  as  farmers,  but  as  landowners.  They  are  like  the  lucky 
holder  of  urban  sites  in  a  newly  established  town.  The  great 
mass  of  farmers  do  not  gain,  but  lose,  —  those  who  supply 
most  of  the  needs  of  the  manufacturing  population  and  who 
buy  most  of  its  products.  The  non-landholding  people  of  the 
manufacturing  town  also  fail  to  gain.  As  will  appear  more 
fully  in  the  sequel,  neither  employers  nor  workmen  are,  under 
conditions  of  free  competition,  permanently  better  off.  Only 
those  gain  in  the  end  whose  sites,  whether  agricultural  or  urban, 
are  more  advantageously  situated  under  the  new  distribution  of 
the  population. 

Closely  connected  with  the  home  market  argument  is  that 
in  regard  to  employment.  That  protective  duties  add  to  the 
demand  for  labor  seems  patent  to  the  everyday  man,  and 
especially  to  the  workingman.  When  imports  are  kept  out,  is 
it  not  clear  that  more  employment  exists  for  the  workmen 
who  make  at  home  the  things  formerly  imported  ?  Here,  again, 
people  see  only  the  first  and  most  obvious  results,  and  do  not 
stop  to  think  what  other  results  must  follow.  If  there  are  less 
imports,  there  will  be  less  exports;  and  labor,  if  employed 
more  in  the  new  way,  is  employed  less  in  the  old.  One  of  the 
most  persistent  of  economic  errors  is  the  notion  that  employ- 
ment is  an  end,  not  a  means;  and  one  of  the  hardest  things 
to  fasten  in  the  average  person's  thinking  is  that  the  end  to 
which  employment  should  be  directed  is  the  increase  of  the 
national  income,  —  the  total  flow  of  consumable  goods  and 
of  services  which  constitutes  the  real  revenue  of  the  community. 


512  INTERNATIONAL  TRADE 

Most  workingmen,  for  reasons  which  are  stated  elsewhere,1 
oppose  labor-saving  appliances,  and  welcome  arrangements 
which  seem  to  increase  the  demand  for  labor.  Most  of  them 
are  instinctively  protectionists,  since  the  same  fallacies  are 
current  in  arguments  for  protection  as  in  arguments  for  in- 
creasing the  employment  of  labor.  The  workmen  of  any  one 
group  or  set  are  concerned  solely  with  their  own  share  of  the 
national  income.  Anything  which  adds,  or  seems  to  add,  to 
the  demand  for  their  particular  kind  of  labor  is  of  course  wel- 
comed; and  then,  by  an  easy  transition  from  the  particular 
to  the  general,  it  is  inferred  that  all  labor  is  more  in  demand 
because  of  the  circumstances  which  increase  the  demand  in 
this  particular  direction. 

One  form  of  the  creating-employment  argument  is  that  there 
is  always  unemployed  labor  and  always  unemployed  capital. 
Put  on  a  duty,  bring  this  labor  and  capital  together  for  making 
an  article  previously  imported,  —  and  is  there  not  a  gain  ? 
Obviously,  the  same  question  could  be  asked  if  the  labor  and 
capital  were  brought  together  in  making  an  article  previously 
exported,  —  is  there  not  (on  protectionist  principles  of  the 
mercantile  kind)  even  a  greater  gain  ?  The  truth  is,  that  this 
problem  is  far  removed  from  the  protective  controversy.  Un- 
employed labor  is  a  grave  social  evil ;  unemployed  capital  is  a 
real  waste.  Some  proportion  of  unemployment,  no  doubt,  is 
inevitable  both  for  labor  and  for  capital ;  it  results  from  prog- 
ress in  industry,  from  shifts  between  occupations,  from  the 
processes  of  change  and  transition.  To  minimize  it  is  among 
the  most  important  of  public  tasks.  It  is  also  among  the 
most  difficult.  There  is  no  ground  for  supposing  that  a  system 
of  protection  would  affect  it  one  way  or  the  other. 

If  a  new  industry  is  stimulated  in  a  country  by  a  protective 
duty,  it  by  no  means  follows  that  the  labor  which  is  unem- 
ployed is  adapted  to  that  particular  industry,  or  is  in  a  place 

1  See  Book  V,  Chapter  51,  §  3.  The  discussion  of  this  topic,  as  of  others  in  the 
protective  controversy,  has  a  wide  range,  and  more  particularly  touches  the  field 
of  the  distribution  of  wealth,  covered  in  Book  V. 


PROTECTION  AND  FREE  TRADE  513 

where  it  can  take  advantage  of  the  new  opportunities.  It 
takes  time  for  adaptation  and  removal.  Given  time,  however, 
all  the  forces  of  spontaneous  activity  tend  to  bring  together 
unemployed  labor  and  unemployed  capital  in  any  case.  And 
even  supposing  the  wildly  improbable  outcome  that  the  unem- 
ployed forces  were  really  brought  together  in  an  industry 
created  by  protection,  —  the  solution  of  the  problem  would  be 
but  temporary.  Inventions  and  improvements,  redistribution 
of  industries  and  of  population,  crises  with  all  their  dislocating 
effects,  would  ere  long  cause  the  problem  to  present  itself  again. 
A  country  quite  without  international  trade,  shut  within  its 
own  borders,  would  be  confronted  with  unemployment,  as  with 
other  ills,  so  long  as  its  industry  rested  on  private  property, 
complex  division  of  labor,  free  movement  of  labor  and  capital, 
hopes,  fears,  and  mistakes  in  the  business  world. 

§  3.  In  the  United  States,  by  far  the  most  common  and 
most  effective  argument  in  favor  of  protection  is  that  it  makes 
wages  high,  or  enables  wages  to  be  high.  With  many  persons 
it  is  an  accepted  article  of  faith  that  American  wages  can  be 
kept  high,  and  the  American  standard  of  living  can  be  main- 
tained, only  if  there  is  protection  against  the  goods  made  by 
the  cheaper  labor  of  other  countries.  Yet  I  conceive  that  no 
argument  in  favor  of  protection  is  more  fallacious  than  that 
of  pauper-labor  competition. 

Evidently  the  argument  is  not  of  universal  application. 
How  could  there  be  any  exports  at  all,  if  lower  wages  always 
gave  the  foreigner  an  advantage?  As  much  is  exported  (vir- 
tually as  much)  as  is  imported.  The  exported  goods  are  made 
by  laborers  who  get  high  wages  in  the  United  States;  yet 
these  goods,  so  far  from  being  undersold  in  foreign  countries, 
are  themselves  underselling  those  of  the  foreigners.  The  ex- 
planation is  simple  :  the  efficiency  of  labor  in  the  exporting 
industries  is  great,  and  therefore  high  wages  and  low  prices 
coexist.  And  that  effectiveness  is  the  cause  of  the  high  money 
wages;  and  these  wages,  again,  may  or  may  not  be  accom- 
panied by  high  prices  of  the  domestic  commodities  which  are 

2L 


514  INTERNATIONAL  TRADE 

outside  the  realm  of  international  trade.  This  whole  subject 
cannot  be  understood  except  in  connection  with  the  principle 
of  comparative  costs.  In  those  industries  in  which  the  United 
States  has  a  comparative  advantage  in  effectiveness,  high 
wages  can  be  paid,  and  yet  low  prices  accepted,  with  profit  to 
the  employing  capitalists.  In  those  in  which  there  is  no  such 
advantage,  the  current  high  wages  cannot  be  afforded.  In  this 
latter  class,  though  labor  be  as  effective  as  in  competing  for- 
eign countries,  and  though  the  industries  in  that  sense  are  well 
adapted  to  the  country,  they  encounter  the  difficulty  that 
other  industries  are  still  better  adapted,  yield  still  larger 
returns,  and  set  up  a  prevalent  high  rate  of  wages  which 
these  less  advantageous  industries  cannot  sustain. 

Of  course  it  is  true  that,  when  once  industries  which  possess 
no  sufficient  advantage  have  been  established  under  the  shelter 
of  protective  duties,  high  wages  can  be  maintained,  in  those 
industries,  only  by  the  continuance  of  the  duties.  This  sort  of 
situation  —  the  existence  of  industries  dependent  on  duties  — 
was  historically  the  occasion  of  the  protectionist  argument 
about  wages.  Wages  have  always  been  higher  in  the  United 
States  than  in  other  countries.  Before  a  protective  system 
was  adopted,  it  would  have  been  absurd  to  say  that  they  were 
due  to  any  such  system.  When  new  industries  are  called  into 
existence  by  protection,  they  must,  of  course,  in  order  to  secure 
their  workmen,  pay  the  same  wages  as  are  generally  prevalent  ; 
and  once  they  are  established,  it  can  be  maintained  with  reason 
that  high  wages  to  their  workmen  are  dependent  on  protec- 
tion. As  long  as  the  workmen  remain  in  those  industries,  the 
high  wages  they  receive  are  so  dependent. 

The  free  trader  argues  that  if  the  duties  were  given  up  and 
the  protected  industries  pushed  out  of  the  field  by  foreign 
competitors,  the  workmen  engaged  in  them  would  find  no  less 
well-paid  employment  elsewhere.  Presumably  they  would 
betake  themselves  to  the  exporting  industries,  in  which  labor 
is  advantageously  applied.  The  protectionist  answers  that 
there  would  then  be  "overproduction"  ha  those  industries, — • 


PROTECTION  AND  FREE  TRADE  515 

that  more  goods  would  be  produced,  prices  would  be  lower, 
and  then  wages  lower.  No,  replies  the  free  trader,  —  there 
would  be  more  goods,  but  not  lower  prices  or  lower  wages. 
For  there  is  a  new  demand  for  these  exportable  goods,  pari 
passu  with  the  new  supply.  Goods  are  imported  which  were 
formerly  made  by  protected  industries.  The  new  imports 
must  be  paid  for  by  exports ;  there  is  a  new  foreign  "  market," 
replacing  the  last  domestic  "market."  The  eventual  result, 
says  the  free  trader,  is  that  more  workmen  will  be  turned  to 
the  advantageous  industries,  and  more  goods  will  be  exported 
in  exchange  for  more  imports;  there  will  be  higher  wages  (in 
terms  of  commodities)  all  around  within  the  country,  resulting 
from  the  more  productive  direction  of  its  labor. 

In  all  this  reasoning,  the  free  trader  is  right.  There  are 
some  further  questions  concerning  the  effect  of  the  supposed 
change  on  money  wages,  which  will  be  presently  considered ; l 
but  these  do  not  affect  the  essentials  of  the  argument.  Of 
course  the  reasoning  applies  only  to  the  long-run  course  of 
events.  It  assumes  that  labor  (and  capital,  too)  will  shift 
from  a  less  profitable  to  a  more  profitable  industry ;  that  when 
a  protected  industry  is  deprived  of  support,  and  those  engaged 
in  it  are  confronted  with  the  alternative  of  either  accepting 
lower  wages  or  quitting,  they  will  quit  and  go  to  better-paid 
occupations.  Any  such  process  of  transition  is  difficult  and 
trying.  When  carried  out  on  a  very  large  scale,  —  say  by 
the  sudden  abandonment  of  a  protective  system  under  whose 
shelter  many  industries  have  grown  up,  —  it  may  cause  for  a 
time  something  like  disaster.  The  extent  to  which  existing 
industries  are  in  fact  dependent  on  protection,  is  commonly 
exaggerated  by  both  its  advocates  and  its  opponents;  but, 
none  the  less,  the  question  of  vested  interests  is  a  very  trouble- 
some one.  It  may  be  deemed  better,  on  the  whole,  to  let  things 
stand,  or  change  them  very  slowly  and  cautiously,  rather  than 
incur  the  disturbance  and  damage  of  a  radical  change.  But 
all  this  does  not  affect  the  question  of  principle,  which  is  not 

1  See  Chapter  37,  5  1. 


516  INTERNATIONAL  TRADE 

squarely  presented  unless  we  ask  what  would  have  been  the 
best  policy  from  the  outset. 

The  question  of  wages  —  to  anticipate  for  a  moment  —  is  at 
bottom  one  of  productivity.1  The  greater  the  productivity  of 
industry  at  large,  the  higher  will  be  general  wages.  There  are 
very  intricate  problems  as  to  the  precise  nature  of  this  con- 
nection, and  as  to  the  deductions  from  the  general  product, 
or  the  shares  in  the  general  product,  on  account  of  interest, 
rent,  employer's  gains.  Under  certain  contingencies,  it  is 
conceivable  that  protective  duties  will  affect  the  various  pro- 
cesses of  deduction  or  sharing,  and  so  will  influence  wages 
otherwise  than  through  their  effect  on  product.  But  these 
are  rare  contingencies,  and  are  negligible  for  the  discussion  of 
the  main  problem.  Prima  fade,  protection  restricts  the  geo- 
graphical division  of  labor,  causes  industry  to  turn  to  less 
advantageous  channels,  lessens  the  productivity  of  labor,  and 
so  tends  to  lower  the  general  rate  of  wages. 

§  4.  One  phase  of  the  wages  argument  appears  in  the  propo- 
sition, much  heard  in  the  United  States  of  late  years,  that 
duties  should  be  so  adjusted  as  to  "equalize  cost  of  production" 
between  this  country  and  foreign  countries.  This  has  been 
propounded  as  a  "scientific"  solution  of  the  tariff  problem. 
When  the  labor  cost  of  a  commodity,  it  is  said,  is  higher  in  the 
United  States,  let  a  duty  be  imposed  sufficient  to  enable  the 
domestic  producer  to  meet  his  foreign  competitor  on  terms  of 
equality,  —  and  then  let  them  fight  it  out.  It  needs  little 
reflection  to  show  that  such  a  policy,  consistently  followed, 
means  the  complete  wiping  out  of  all  the  advantages  from 
international  trade,  nay,  the  wiping  out  of  international  trade 
altogether.  The  greater  the  disadvantage  of  a  country  in 
producing  a  given  commodity,  the  more  labor  must  be  given 
to  producing  it,  and  the  higher  will  be  the  expenses  of  the 
employers.  In  proportion  as  the  efficiency  or  productivity  of 
labor  is  less,  more  must  be  paid  out  in  wages  to  secure  the 
greater  amount  of  labor  required  per  unit  of  output;  then 

1  See  below,  Book  V,  Chapter  51. 


PROTECTION  AND  FREE  TRADE  517 

"labor  cost"  is  so  much  higher;  and  duties  must  be  made 
correspondingly  high  if  the  labor  cost  is  to  be  equalized.  Any 
commodity,  however  unsuited  to  the  industrial  aptitudes  of  a 
country,  can  be  produced  in  it  if  only  its  price  is  made  high 
enough;  and  by  keeping  out  foreign  competitors,  there  is  no 
limit  (short  of  the  possible  extinction  of  demand)  to  the  rise 
in  price.  If  the  principle  of  equalizing  cost  were  consistently 
carried  out,  we  should  exert  ourselves  most  strenuously  to  pro- 
mote by  high  duties  the  domestic  production  of  an  article 
according  as  we  gain  most  from  its  importation.  No  doubt, 
the  persons  who  propose  the  principle  would  probably  refrain 
from  pushing  it  to  its  logical  conclusion.  They  would  shrink 
from  clapping  on  duties  high  enough  to  cause  lemons  to  be 
grown  in  Maine,  or  (to  use  Adam  Smith's  familiar  illustration) 
grapes  in  Scotland ;  though  all  this  could  be  done  if  labor  costs 
were  unflinchingly  equalized.  They  think  of  the  commodities 
for  which  the  domestic  disadvantages  are  not  glaring.  But 
the  difference  is  only  one  of  degree.  There  is  no  rational 
reason  for  saying  that  a  disadvantage  in  labor  cost  —  that  is, 
a  disadvantage  in  industrial  effectiveness  —  of  twenty  per 
cent  should  be  offset  by  a  protective  duty,  but  that  one  of 
fifty,  one  hundred,  two  hundred  per  cent  should  not  be  so 
offset. 

One  thing  is  ^  be  said  in  favor  of  the  notion :  duties  should 
certainly  not  exceed  the  rates  necessary  to  "equalize  labor  cost." 
If  they  so  exceed,  there  is  the  possibility  that  a  domestic  mo- 
nopoly may  levy  additional  burdens  on  the  consumers.  This 
possibility  arises  if  competition  among  the  domestic  producers 
is  not  free.  As  will  presently  appear,  no  special  benefits  to 
the  protected  producers  accrue,  and  no  monopoly  profits  are 
derived,  if  domestic  competition  keeps  prices  down  to  the  level 
of  expenses  of  production.  But  where  there  is  a  possibility 
of  monopoly  and  of  abnormal  profit  to  the  protected  capitalists, 
it  is  not  unreasonable  to  say  that,  if  they  must  have  protective 
duties,  these  should  not  be  greater  than  suffice  to  enable  the 
industry  to  be  carried  on.  But  it  is  absurd  to  urge  that  the 


518  INTERNATIONAL  TRADE 

proposal,  even  in  this  form,  is  a  "scientific"  solution  of  the 
protective  question.  It  simply  amounts  to  saying  that  pro- 
tection should  not  be  carried  to  the  point  where  it  may  foster 
monopoly. 

§  5.  The  strength  of  the  general  presumption  against  pro- 
tection will  be  made  clearer  by  a  consideration  of  the  working 
of  protective  duties  in  greater  detail. 

When  a  duty  is  imposed  on  a  commodity,  its  price  usually 
rises  by  the  amount  of  the  duty.  Usually  it  does  so,  but  not 
necessarily;  and  not  always  at  once,  but  often  only  hi  the 
end,  even  in  those  cases  where  this  normal  result  is  to  be  looked 
for.  Strictly,  the  result  is  to  be  expected  only  if  the  com- 
modity is  produced  under  free  competition  and  under  the 
conditions  of  constant  return.1  Ordinarily  a  duty,  like  any  tax 
on  a  commodity,  increases  by  so  much  the  expense  of  getting 
the  article  to  market.  The  amount  of  the  tax  or  duty  must 
be  added  to  the  price  charged  the  consumer  if  the  producer  is 
to  get  his  usual  return.  But  a  rise  in  price  has  its  effect  on 
demand.  Very  likely  the  same  quantity  cannot  be  sold  at  the 
higher  price.  The  producer,  none  the  less,  may  not  be  able  to 
lessen  the  supply  with  any  promptness;  he  may  have  a  large 


1  If  a  commodity  is  produced  under  the  conditions  of  diminishing  or  of  in- 
creasing return,  the  case  is  obviously  different.  Under  diminishing  return,  a  tax 
per  unit  of  quantity  tends  to  check  consumption,  lessen  production,  lower  mar- 
ginal cost,  and  so  increase  price  by  less  than  the  amount  of  the  tax.  Conversely, 
under  increasing  return,  a  tax,  by  lessening  consumption,  tends  to  raise  marginal 
cost  and  so  to  increase  price  by  more  than  the  amount  of  the  tax.  A  tax  on  a 
monopolized  article  works  out  its  results  through  the  principles  of  monopoly 
value ;  and  it  is  quite  conceivable  that  such  a  tax,  in  the  case  of  an  article  for 
which  the  demand  is  highly  elastic,  will  cause  little  rise  in  price,  and  will  be  borne 
chiefly  by  the  monopoly  producer.  All  these  possibilities,  however,  appear  in 
the  case  of  internal  taxes  quite  as  much  as  in  that  of  import  duties.  They 
present  no  special  problems  in  international  trade ;  they  are  part  of  the  theory 
of  value.  Moreover,  they  are  not  often  of  much  practical  consequence.  As  in- 
timated in  the  text,  the  usual  case  is,  in  the  long  run,  that  of  constant  return. 
The  most  important  qualification  of  the  general  reasoning  probably  is  to  be 
made  for  articles  subject  to  a  quasi  monopoly  of  good  will  or  trademark,  where 
the  producers,  though  they  have  no  permanent  or  unqualified  monopoly,  make 
unusual  profits  for  a  considerable  time,  and  can  possibly  be  deprived  of  a  part 
of  these  profits  through  the  operation  of  a  tax.  Compare  what  is  said  below, 
Book  VIII,  Chapter  70. 


PROTECTION  AND  FREE  TRADE  519 

plant  committed  to  making  the  particular  thing.  For  a  while, 
therefore,  price  may  be  raised  by  less  than  the  amount  of  the 
tax;  conceivably  it  may  not  be  raised  at  all.  Only  as  supply 
is  slowly  adjusted  to  the  new  situation  will  normal  conditions 
be  regained  and  the  price  raised  so  as  to  recoup  the  producers 
and  dealers  for  their  increased  expenses  of  production.  Hence 
it  is  true  that  a  duty  on  imports,  and  indeed  any  tax  on  a 
commodity,  may  fall  for  a  while  on  the  producer,  foreign  or 
domestic ;  while  yet  in  the  end,  it  falls  with  its  full  weight  on 
the  consumer. 

So  long  as  the  commodity  continues  to  be  imported,  this 
rise  in  price  brings  a  tax,  but  no  national  loss.  It  is  true  that 
the  consumers  are  in  effect  deprived  of  so  much  of  their  in- 
comes ;  but  what  they  lose,  the  public  treasury  gains.  Taxes 
are  presumably  levied  for  useful  public  purposes.  They  do 
not  stand  for  waste.  If  the  needed  revenue  had  not  been  got 
by  customs  duties,  it  would  have  been  got  in  some  other  way, 
and  the  same  tax  would  have  been  levied  on  the  public. 

Suppose,  however,  that  after  the  duty  has  been  imposed, 
domestic  producers  supplant  the  foreigners.  They  charge  higher 
prices  than  the  foreigners  did ;  they  must  charge  higher  prices, 
hi  order  to  get  a  profit.  If  they  could  bring  the  commodity 
to  market  at  the  same  price  as  the  foreigner,  there  never  would 
have  been  any  importation.  The  fact  that  the  domestic  pro- 
ducers did  not  enter  the  field  before  the  duty  was  imposed, 
shows  that  they  are  under  a  disadvantage.1  When  they  are 
stimulated  by  the  duty  to  enter  the  field,  and  sell  their  article 
at  a  higher  price  than  the  imported  one  had  previously  cost, 
the  consumer  pays  the  tax  in  precisely  the  same  way  as  if  the 
article  continued  to  be  imported,  —  that  is,  in  the  shape  of 
higher  prices.  Only,  there  is  in  this  case  no  revenue  to  the 
public  treasury.  The  extra  price  stands  for  so  much  bonus 
to  the  domestic  producers,  to  enable  them  to  maintain  them- 
selves hi  a  disadvantageous  industry.  And  it  represents  so 
much  national  loss.  In  most  discussion  of  protective  duties, 

1  But  see  what  is  said  in  Chapter  37,  §  2,  on  protection  to  young  industries. 


520  INTERNATIONAL  TRADE 

at  least  in  the  United  States,  the  common  assumption  is  that 
the  creation  of  a  domestic  industry,  supplying  a  commodity 
which  was  previously  imported,  represents  so  much  gain. 
Strictly,  the  reverse  is  the  case.  The  payment  of  duties  on 
continued  imports  brings  no  loss;  the  loss  arises  from  the 
domestic  supply. 

Hence,  where  the  principle  of  free  trade  is  consistently  fol- 
lowed, a  customs  duty  on  an  article  is  accompanied  by  an 
internal  tax  of  the  same  amount  on  the  domestic  product. 
Then  the  combined  taxes  operate  solely  to  bring  in  revenue, 
and  have  no  effect  on  the  direction  of  industry  within  the 
country.  Such  is  the  present  (1910)  system  in  Great  Britain. 
Her  customs  duties  are  limited  to  a  few  articles  of  general 
consumption,  such  as  tea,  coffee,  cocoa,  sugar,  beer,  spirits, 
tobacco.  On  such  articles  as  beer  and  spirits,  an  internal  tax 
is  imposed  at  the  same  rate  as  the  customs  duty.  Tea,  coffee, 
cocoa,  sugar,  and  the  like  will  not  be  produced  within  the  coun- 
try under  any  circumstances,  or  at  least  not  under  any  such 
moderate  duties  as  are,  in  fact,  levied ;  the  duties  on  them  are  of 
a  purely  revenue  sort.1  Sometimes,  in  popular  discussion,  it 
is  said  that  the  imposition  of  any  duties  whatever  is  incon- 
sistent with  the  principle  of  free  trade.  Obviously,  this  is  a 
mistake;  it  is  only  the  imposition  of  duties  that  cause  a  sub- 
stitution of  domestic  products  for  imported  that  conflicts  with 
the  principle. 

When  a  customs  duty  operates  to  bring  into  existence  a  domes- 
tic industry,  the  domestic  producers  do  not  make  unusual  gains ; 
that  is,  not  if  the  commodity  be  brought  to  market  under  com- 
petitive conditions.  Very  likely  those  who  take  the  initiative 
in  producing  the  article  make  unusual  profits  on  the  first  im- 

1  Tobacco  is  in  the  same  class  with  tea  and  coffee ;  all  of  it  is  imported.  Its 
cultivation  in  the  United  Kingdom  is  prohibited,  on  the  assumption  (a  reason- 
able one)  that  only  sporadic  cases  of  its  cultivation  would  appear  in  any  case,  and 
that  the  supervision  and  taxation  of  these  would  cost  more  than  any  internal 
revenue  would  justify.  The  most  convenient  way  to  collect  the  British  tax  on 
tobacco  is  to  levy  a  customs  duty  on  the  imports,  and  prevent  once  for  all  domes- 
tic production. 


PROTECTION  AND  FREE  TRADE  521 

position  of  a  duty.  In  time,  however,  profits  will  fall  to  the 
normal  level,  and  at  that  normal  level  prices  will  be  higher  than 
foreign  prices  only  if  a  real  disadvantage  handicaps  the  domestic 
producers.  In  other  words,  nobody  gains,  and  the  community 
loses,  —  the  loss  consisting  in  its  paying  more  for  the  protected 
article  than  it  would  have  had  to  pay  without  the  protection. 

Where  there  are  not  competitive  conditions, — where  there  is  a 
monopoly,  complete  or  partial,  permanent  or  temporary,  —  the 
domestic  producers  may  make  unusual  gains.  To  the  extent 
that  they  do  so,  another  item  enters  into  the  account.  There 
may  not  only  be  some  national  loss,  but  in  addition  a  shift  of  rev- 
enue from  one  set  of  persons  to  another  set.  The  commodity 
may  be  produced  at  higher  expense  within  the  country,  and  may 
have  to  sell  on  that  ground  for  a  higher  price  than  if  imported. 
It  may  sell  for  a  price  still  higher,  because  the  domestic  producers 
are  in  a  position  to  keep  out  competition  and  make  unusual  gains. 
It  may  even  happen  that  the  imposition  of  a  duty  enables  do- 
mestic producers  who  are  under  no  disadvantage  at  all,  and  who 
could  bring  the  article  to  market  as  cheaply  as  the  foreigners, 
to  form  a  combination  and  exact  a  price  higher  than  the  com- 
petitive one.  In  such  a  case  there  is  no  national  loss  at  all. 

Naturally  enough,  this  last-mentioned  case  is  precisely  that  in 
which  protection  is  most  unpopular,  though  in  a  sense  least  harm- 
ful. Where  the  protected  producers  make  no  unusual  gains,  the 
system  is  supposed  to  work  not  unfairly.  The  vague  and  dis- 
tant consequences  on  general  industrial  efficiency  which  strict 
economic  analysis  brings  out  are  within  the  ken  of  comparatively 
few  persons.  The  direct  consequence  of  robbing  Peter  to  pay 
Paul,  which  appears  in  case  of  monopoly,  strikes  the  popular 
imagination  at  once  and  leads  to  indignation,  even  though,  on 
cool  consideration,  it  appears  that  Paul  gains  what  Peter  loses, 
and  that  the  community  as  a  whole  is  no  worse  off. 

The  ease  with  which  popular  feeling  can  be  roused  against  a 
monopoly  has  led  to  the  frequent  statements  that  protection 
breeds  monopoly.  The  former  head  of  the  American  Sugar  Re- 
fining Company  —  a  "trust"  or  would-be  monopoly  —  once 


522  INTERNATIONAL  TRADE 

remarked  to  a  congressional  committee  of  investigation  that 
"the  tariff  is  the  mother  of  all  trusts,"  and  the  aphorism  became 
the  text  of  many  free  trade  sermons.  Its  truth  is  limited.  The 
causes  of  combination  are  deeply  rooted  in  the  industries  of  mod- 
ern times.  They  are  found  mainly  in  the  development  of  pro- 
duction on  a  great  scale;  and  it  is  superficial  to  ascribe  a 
tendency  so  far-reaching  to  a  single  external  cause. 

It  is  true  that  protective  duties  sometimes  bring  combination 
more  easily  and  at  an  earlier  date,  and  sometimes  increase 
the  gains  from  it.  This  is  particularly  the  case  where  the 
situation  is  ripe  for  consolidation  within  the  country,  but  not 
ripe  for  international  consolidation,  —  a  stage  of  development 
not  uncommon,  especially  in  the  United  States  during  recent 
years.  It  is  not  to  be  supposed  that  the  tendency  to  combina- 
tion, strong  and  far-reaching  though  it  is,  works  out  its  results 
automatically,  irrespective  of  favoring  causes  or  legislative  influ- 
ences. Protective  duties  have  been  in  the  United  States  during 
the  last  generation  a  favoring  cause.  Though  the  trust  problem 
is  in  its  essence  very  different  from  that  of  protection,  —  a  graver 
problem,  and  of  far  larger  social  consequence,  —  the  two  inter- 
lace in  some  industries. 

Just  as  protective  duties  may  bring  unusual  gains  to  some 
capitalists,  if  these  can  keep  out  competitors,  so  they  may  bring 
exceptionally  high  wages  to,  some  workmen,  on  the  same  condi- 
tion of  keeping  out  competition.  This  is  commonly  less  easy 
for  the  workmen,  but  it  is  not  impossible,  at  least  for  considerable 
stretches  of  time.  It  is  most  feasible  in  occupations  of  the  handi- 
craft sort,  calling  for  special  acquired  skill,  and  not  subjected  to 
the  machine  processes.  Such  is,  or  at  least  has  been  until  very 
recent  times,  glass  blowing.  Certain  kinds  of  glass,  especially 
window  glass,  have  called  for  the  services  of  the  blowers,  whose 
trade  is  not  easily  learned.  They  have  had  a  tight  union,  have 
restricted  entrance  to  the  trade,  and  have  maintained  exception- 
ally high  wages.  The  employers  in  this  industry  have  also  com- 
bined ;  so  that  there  has  been  a  double  monopoly  of  capitalists 
and  workmen,  promoted  by  very  high  import  duties.  The  two 


PROTECTION  AND  FREE  TRADE  523 

favored  sets  have  alternately  quarreled  and  joined  forces,  with 
the  advantage  in  the  end,  as  usual  in  such  cases,  to  the  employers. 
Here,  as  elsewhere,  new  inventions  have  come  in,  and  the  applica- 
tion of  machinery  has  tended  to  deprive  the  handicraft  workmen 
of  their  special  advantage.  But  so  long  as  the  old  conditions 
remained  (and  the  transition  to  machinery  is  by  no  means  com- 
pleted in  this  industry)  the  tariff  system  may  be  said  really  to 
have  kept  up  wages,  —  not  wages  of  workmen  in  general,  but 
those  of  a  limited  group.  And  here,  as  in  the  case  of  govern- 
ment industries,1  workmen  in  general  are  likely  to  regard  with 
approval  this  advantage  to  the  small  group,  even  though  it  may 
mean  higher  charges  to  consumers  and  to  the  great  body  of  the 
workmen  as  consumers.  Anything  that  means  high  wages  to 
any  set  of  manual  laborers  finds  favor  with  the  labor  leaders 
and  doubtless  with  the  dumb  rank  and  file  also ;  partly  from 
mere  clannish  sympathy,  but  mainly  from  inability  to  dis- 
tinguish between  the  causes  that  bring  real  advantage  to  all 
and  those  that  bring  advantage  to  a  favored  few  only. 
1  Compare  what  is  said  in  Book  VII,  Chapter  62,  §  5. 


CHAPTER  37 

PROTECTION  AND  FREE  TRADE,  continued.     SOME  ARGUMENTS 
FOR  PROTECTION 

§  1.  The  simpler  aspects  of  the  protective  controversy  have 
been  considered  in  the  preceding  chapter,  —  those  which  bring 
out  most  strongly  the  case  for  free  trade.  They  tend  to  show 
that  the  increase  in  price  due  to  a  protective  duty  represents  a 
net  loss.  But  there  are  ways  in  which  the  loss  may  be  offset. 
The  consideration  of  the  various  possible  modes  of  offset  brings 
out  those  arguments  for  protection  which  have  some  degree  of 
validity. 

First  there  is  a  possible  effect  on  the  terms  of  international  ex- 
change.1 The  first  influence  of  a  duty  is  almost  necessarily  to 
lessen  imports.  Even  if  it  be  a  purely  revenue  duty,  it  will  lessen 
them ;  the  rise  in  price  will  cause  a  decline  in  consumption,  unless 
demand  happens  to  be  quite  inelastic.  If  the  duty  is  protective, 
and  operates  to  stimulate  domestic  production,  the  decline  in 
imports  will  be  more  certain  arid  greater.  Hence,  the  movement 
of  specie  will  be  into  the  country.  Then  will  ensue  the  train  of 
consequences  (always  supposing  the  flow  of  specie  to  be  consider- 
able and  continued)  already  familiar  to  the  reader.  Prices  and 
incomes  rise  within  the  country,  and  fall  in  foreign  countries. 
Exports  in  time  begin  to  be  checked,  as  the  prices  of  exported 
articles  rise ;  imports  are  stimulated,  as  the  prices  of  imported 
articles  fall.  The  length  of  this  period  of  transition,  and  the 
extent  of  the  change  before  it  comes  to  an  end,  depend  on  the 
play  of  reciprocal  demand.  If  the  commodities  exported  from 
a  country  are  of  a  sort  insistently  demanded  in  foreign  countries ; 
and  if,  on  the  other  hand,  the  commodities  which  it  imports  are 
not  such  as  to  be  consumed  more  largely  as  their  prices  fall,  — '• 

1  In  the  sense  in  which  that  phrase  was  used  and  explained  in  Chapter  35. 

524 


SOME  ARGUMENTS  FOR  PROTECTION  525 

then  the  change  may  be  considerable.  Eventually  equilibrium 
is  reestablished ;  exports  diminish  and  imports  increase  until 
payments  again  balance.  When  this  stage  is  finally  reached, 
the  country  that  imposed  the  duty  will  have  higher  money  in- 
comes and  higher  prices.  The  higher  incomes  will  be  of  no  bene- 
fit so  far  as  domestic  purchases  go,  since  within  the  country 
prices  have  risen  in  the  same  proportion.  But  they  will  be  of 
advantage  in  the  purchase  of  things  imported. 

In  such  a  case,  there  is  a  balance  of  loss  against  gain.  The 
consumers  lose  as  purchasers  of  the  protected  articles,  that  is,  of 
those  made  at  home  under  the  influence  of  the  duties ;  but  they 
gain  as  purchasers  of  things  that  continue  to  be  imported.  Even 
if  the  particular  articles  subjected  to  the  duties  are  completely 
shut  out,  there  will  remain  imports  of  other  articles.  Thus, 
in  the  United  States,  protective  duties  during  the  last  generation 
have  served  to  prohibit  completely  the  importation  of  many 
manufactures ;  but  tea,  coffee,  sugar,  tropical  articles  of  all  sorts, 
sundry  raw  materials,  some  finer  manufactures,  have  continued 
to  come  in.  All  these,  if  the  reasoning  of  the  preceding  para- 
graph holds  good,  are  got  in  reality  more  cheaply  because  of  the 
duties.  It  is  true  that  some  of  the  things  imported,  being  still 
subject  to  duty,  are  absolutely  raised  in  price;  but  for  this  ad- 
vance there  is  a  full  recompense  in  the  revenue  received  by  the 
public  treasury,  and  in  the  relief  (presumably)  from  other  taxes. 
But  even  these  imports  are  not  raised  in  price  by  the  full  amount 
of  the  duties,  —  there  is  some  offset  because  foreign  prices  in 
general  have  fallen,  and  domestic  money  incomes  have  risen. 

How  far  is  reasoning  of  this  sort  applicable  to  the  concrete 
facts  ?  Precisely  to  the  same  extent  as  the  general  reasoning  on 
the  distribution  of  the  gains  from  international  trade.  How 
difficult  it  is  to  verify  this  in  detail  has  already  been  shown. 
Take  the  case  of  the  United  States  during  the  last  thirty  or  forty 
years,  when  a  system  of  high  protective  duties  has  been  steadily 
maintained.  Throughout  the  period  a  whole  series  of  other 
factors  has  been  influencing  international  trade  in  opposing  ways. 
The  protective  system,  in  so  far  as  it  has  restricted  imports,  has 


526  INTERNATIONAL  TRADE 

been  among  the  factors  making  for  gain  in  the  terms  of  exchange. 
The  high  tariff  has  contributed  something  toward  a  higher 
range  of  money  incomes.  How  far  the  gain  from  this  source 
has  served  to  offset  the  loss  from  the  domestic  commodities 
produced  and  sold  at  higher  cost,  is  impossible  of  calculation. 
It  is  a  gain,  at  best,  little  reckoned  with  in  the  popular  contro- 
versy. Most  people  who  try  to  persuade  the  public  to  their 
opinions  on  one  or  another  side  of  the  tariff  question  reason 
only  about  what  is  "good  for  business,"  about  employing  labor, 
higher  prices  to  consumers,  extortionate  monopolies.  Even  the 
simpler  questions  really  involved,  as  to  the  general  effects  of  the 
geographical  division  of  labor,  they  perceive  but  vaguely ;  the 
more  intricate  ones  here  considered  are  quite  beyond  the  under- 
standing not  only  of  the  average  man,  but  of  the  average  writer 
on  protection. 

It  is  obvious  that  all  countries  could  not  play  this  game. 
No  one  of  them  has  a  monopoly  of  imposing  import  duties. 
A  condition  of  mutual  grasping  and  recrimination  may  be  im- 
agined, in  which  each  country  tries  to  get  from  the  other  all  it 
can,  with  the  eventual  result  of  some  advantage  to  one  among 
them  in  the  form  of  higher  money  incomes,  and  of  considerable 
loss  to  that  country  and  to  the  rest  from  the  curtailment  of  the 
advantageous  division  of  labor.  Commercial  strife  has  come 
perilously  near  this  state  in  modern  times ;  but  the  immediate 
object  held  in  view  by  the  combatants  has  never  been  that  of 
getting  some  of  the  imports  cheaper.  The  motives  and  objects 
have  invariably  been  of  a  semi-mercantilist  sort :  to  check  im- 
ports generally,  to  market  more  and  more  exports.  Reciprocity 
movements  are  a  compromise  resulting  from  this  familiar  sort 
of  contest. 

§  2.  The  argument  for  protection  to  young  industries  points 
to  another  way  in  which  the  primafade  case  in  favor  of  free  trade 
may  be  fairly  met,  and  the  initial  loss  from  protection  offset. 
The  gist  of  it  is  that  an  industry  really  advantageous  for  a 
country  may  be  prevented  from  arising  because  of  ignorance, 
lack  of  experience,  and  all  the  obstacles  that  impede  success  in 


SOME  ARGUMENTS  FOR  PROTECTION  527 

unfamiliar  undertakings.  Stated  in  another  way,  the  argument  is 
that  while  the  price  of  the  protected  article  is  temporarily  raised 
by  the  duty,  eventually  it  is  lowered.  Competition  sets  in,  it  is 
said,  and  brings  a  lower  price  in  the  end.  The  free  trader 
asks,  why  any  need  of  a  duty,  if  the  domestic  producer  is  really 
able  to  sell  at  a  lower  price  than  the  foreigner  ?  The  answer  is 
that  this  reduction  in  domestic  price  comes  only  with  the  lapse 
of  time.  At  the  outset  the  domestic  producer  has  difficulties, 
and  cannot  meet  foreign  competition.  In  the  end  he  learns 
how  to  produce  to  best  advantage,  and  then  can  bring  the  article 
to  market  as  cheaply  as  the  foreigner,  even  more  cheaply.  Most 
persons  who  use  this  second  form  of  the  argument  (as  to  the 
eventual  lowering  of  domestic  prices)  are  but  dimly  aware  of  its 
identity  with  that  for  protection  to  young  industries.  But  the 
two  arguments  are  one  and  the  same,  resting  on  the  premises 
of  temporary  obstacles  and  eventual  success. 

The  theoretical  validity  of  this  argument  has  been  admitted 
by  almost  all  economists.  The  question  is  how  far  and  under 
what  circumstances  there  is  ground  for  applying  protection  with 
prospect  of  this  good  result.  The  argument  was  first  used  (in 
such  a  way  as  really  to  make  an  impression)  in  the  United  States 
during  the  earlier  part  of  the  nineteenth  century,  when  this  coun- 
try was  in  the  transition  from  dominantly  agricultural  and  com- 
mercial conditions  to  the  stage  of  modern  manufacturing.  It 
was  carried  from  the  United  States  to  Germany  by  its  best-known 
advocate,  Friedrich  List,  who  applied  it  to  Germany  in  her  transi- 
tion during  the  middle  of  that  century  from  semi-medieval  to 
modern  conditions.  The  United  States  was  then  a  "young" 
country,  and  Germany,  though  an  old  country,  had  manufactur- 
ing industries  young  so  far  as  modern  ways  were  concerned. 
There  was  force,  as  to  both  countries,  in  the  contention  that 
manufactures  with  machinery,  power,  large-scale  operation,  were 
certain  to  arise  in  any  case,  or  at  least  had  an  advantageous  op- 
portunity ;  and  that  the  process  of  transition  and  growth  could 
be  made  easier,  and  a  beneficial  result  could  be  reached  at  an 
earlier  date,  by  a  temporary  handicap  on  the  developed  compet- 


528  INTERNATIONAL  TRADE 

itors  of  older  countries.  England,  of  course,  was  the  country 
then  in  the  van,  against  which  such  shelter  was  sought. 

List  and  the  other  more  moderate  advocates  of  nurturing  pro- 
tection said  that  duties  for  this  purpose  should  be  moderate  and 
should  be  temporary.  They  should  be  moderate  —  not  to  ex- 
ceed say  twenty-five  per  cent  — because,  if  the  domestic  industry 
was  at  a  great  disadvantage  in  the  beginning,  there  was  little 
prospect  that  it  would  ever  reach  independence.  They  should  be 
temporary  —  not  to  endure  more  than  twenty  or  thirty  years  — 
because  in  the  end,  by  supposition,  the  domestic  industry  would 
not  need  them,  and  ought  to  be  able  and  willing  to  face  foreign 
competition.  It  was  further  added  that  agricultural  commodi- 
ties and  raw  materials  give  no  field  for  this  sort  of  protection. 
Their  geographical  distribution  is  determined  chiefly  by  unalter- 
able physical  conditions.  Only  in  manufacturing  industries 
can  the  legislator  have  a  prospect  of  encouraging  young  indus- 
tries with  good  results. 

These  limitations  on  the  argument  are  reasonable ;  more  par- 
ticularly the  exclusion  of  agricultural  articles.  The  government 
can  do  much  to  promote  efficiency  in  agriculture;  but  chiefly 
by  diffusing  education,  improving  the  conditions  of  tenure,  pro- 
moting science.  There  are  respectable  arguments,  as  will  pres- 
ently appear,  for  duties  on  such  articles ;  but  they  are  of  a  very 
different  kind  from  this  one,  which  looks  to  promoting  eventual 
cheapness.  The  United  States  long  levied  protective  duties 
on  wool,  but  never  with  any  prospect  of  getting  wool  cheaper 
thereby,  and  in  the  tariff  revision  of  1913  admitted  wool  free. 
Germany  and  France  levy  duties  on  grain,  as  England  did  until 
1846 ;  but  there  was  not  for  England  in  the  earlier  time,  nor  is 
there  for  the  Continental  countries  to-day,  any  outlook  for  se- 
curing domestic  supplies  at  once  more  abundantly  and  cheaply. 

The  other  limitations  seem  also  reasonable;  but  in  actual 
experience  it  is  not  so  clear  that  they  must  be  observed  in 
order  to  secure  the  desired  result.  Not  only  moderate  duties, 
but  very  heavy  ones,  may  set  things  going,  and  eventually 
lead  to  an  independent  domestic  industry.  Of  this  possibility 


SOME   ARGUMENTS  FOR  PROTECTION  529 

the  recent  history  of  the  silk  manufacture  in  the  United  States 
supplies  an  illustration.  A  duty  of  sixty  per  cent  on  silks  was 
imposed  during  the  Civil  War  (1864).  The  object  at  first  was 
revenue.  Then  a  domestic  industry  grew  up ;  and  the  duty  was 
maintained,  even  increased  (especially  in  1897).  Competition 
became  active,  and  great  improvements  were  introduced.  The 
silk  manufacture  has  indeed  been  the  last  of  the  textile  indus- 
tries to  be  adjusted  to  the  machine  processes ;  but  this  develop- 
ment seems  to  have  been  promoted  in  the  United  States  by  the 
establishment  of  the  industry  under  the  shelter  of  protection. 
It  is  certain  that  advances  in  manufacturing  methods  have  taken 
place ;  it  is  probable  that  some  branches  of  the  industry,  though 
not  all,  have  reached  the  stage  where  the  fabrics  can  be  put  on 
the  market  as  cheaply  as  they  can  be  imported.  Nor  is  it  in- 
consistent with  this  outcome  that  the  domestic  producers  still 
clamor  for  protection.  They  are  simply  in  the  habit  of  doing 
so.  Most  business  men  know  very  little  outside  the  immediate 
range  of  their  business.  If  foreign  competition  has  been  long 
shut  off  by  a  high  duty,  they  are  ignorant  of  its  possible  effects ; 
and  if  there  is  a  proposal  to  permit  it  again,  they  object  on  gen- 
eral principles,  even  though  they  are  quite  able  to  hold  their 
own.  The  protective  system,  especially  when  exaggerated  stress 
is  laid  on  it  through  party  politics,  begets  an  abject  fear  of  all 
foreign  competition.  Notwithstanding  this  common  attitude 
of  the  domestic  producers,  it  is  quite  possible  that  the  object 
of  protection  to  young  industries  has  been,  in  fact,  attained ; 
though,  no  doubt,  the  only  certain  way  to  ascertain  this  is  to  re- 
move the  duties  and  let  the  domestic  producers  meet  the  for- 
eigners on  even  terms. 

While  it  is  possible  that  protection  to  young  industries  may  be 
successfully  applied  where  advantages  in  production  rest  not  on 
natural  grounds,  but  on  acquired  skill,  it  is  extremely  difficult  to 
say  how  far  there  is  a  probability  of  such  success.  The  question 
is  part  of  one  much  wider,  —  the  general  causes  of  the  advance 
of  the  arts.  Economic  history  shows  that  the  spread  of  the  va- 
rious trades  and  manufactures  hi  different  countries  has  taken 
2v 


530  INTERNATIONAL  TRADE 

place  by  no  "natural"  process,  and  that  "artificial"  factors, 
such  as  governmental  encouragement,  the  emigration  of  skilled 
artisans,  the  social  and  political  organization  of  a  country,  have 
been  of  large,  often  dominant,  effect.  It  would  be  absurd  to 
apply  to  the  conditions  of  medieval  and  early  modern  times  a 
theory  of  natural  advantages  and  of  settled  differences  in  com- 
parative costs.  On  the  other  hand,  the  lesson  of  history  seems  to 
be  that  other  modes  of  encouragement  have  been  more  effective 
than  protective  duties ;  such  as  rational  education,  free  industry, 
abatement  of  social  barriers,  promotion  of  invention  by  patents 
and  trademarks.  In  very  modern  times,  with  the  wide  diffusion 
of  industrial  education,  the  ease  of  communication,  the  technical 
press,  the  eager  search  for  all  ways  of  investing  capital  at  a  profit, 
• —  the  argument  for  protection  to  young  industries  would  seem 
to  have  lost  much  of.  its  force.  None  the  less,  possibilities  still 
exist,  as  in  the  case  of  the  silk  manufacture  just  cited.  Unfortu- 
nately the  decisive  test  —  eventual  removal  of  duties  —  is  one 
which  domestic  producers  are  likely  always  to  oppose ;  and  hence 
it  is  difficult  to  ascertain  in  any  concrete  case  whether  the  com- 
munity ultimately  gets  a  real  gain  sufficient  to  offset  the  initial 
loss. 

§  3.  Political  considerations  are  often  urged  in  favor  of  protec- 
tive duties. 

The  most  conspicuous  illustration  is  afforded  by  shipping.  In 
the  days  of  wooden  vessels,  a  merchantman  was  not  so  very  differ- 
ent from  a  man-of-war,  and  at  all  events  training  in  handling  the 
two  was  the  same.  Moreover,  a  merchant  marine  was  an  effec- 
tive auxiliary  in  times  of  war.  The  first  of  these  reasons  is  less 
important  in  our  day,  when  steel  battleships  have  intricate  and 
highly  specialized  machinery  of  their  own.  The  second  is  per- 
haps as  important  as  in  former  days.  A  modern  navy  needs  an 
elaborate  complement  of  scout  ships,  supply  ships,  colliers,  not 
to  mention  transports.  A  large  mercantile  marine  supplies 
these,  or  at  least  aids  mightily  in  supplying  the  suddenly  in- 
creased need  of  them  which  arises  in  time  of  war.  If,  to  use 
Adam  Smith's  phrase,  defense  [or  aggression  ?]  is  more  important 


SOME  ARGUMENTS  FOR  PROTECTION  531 

than  opulence,  it  will  be  worth  while  to  promote  a  mercantile 
marine,  even  though  it  cannot  do  its  work  so  cheaply  as  foreign 
shipping.  It  might  even  be  economical  to  subsidize  a  merchant 
marine,  under  conditions  which  assure  the  availability  of  the 
merchant  ships  in  time  of  war ;  this  course  being  very  possibly 
cheaper  than  that  of  hurriedly  creating  an  auxiliary  fleet  when 
war  breaks  out. 

Viewed  simply  as  a  matter  of  the  adjustment  of  a  country's 
productive  forces,  the  protection  of  shipping  presents  no  new 
question  of  principle.  If  foreign  ships  can  carry  goods  more 
cheaply  than  domestic  ships,  let  them  do  it,  says  the  free  trader. 
There  is  no  wonder-working  magic  in  having  your  own  ships. 
They  exist  simply  to  carry  goods ;  and  the  same  grounds  which 
hold  for  letting  the  foreigner  produce  and  sell  goods  to  you,  if 
he  can  do  it  more  cheaply,  hold  for  letting  him  transport  goods 
for  you,  if  he  can  do  it  more  cheaply. 

The  only  economic  peculiarity  in  the  shipping  situation  is  that 
the  same  method  of  protection,  by  duties,  is  not  here  available ; 
at  least  not  for  shipping  engaged  in  foreign  trade.  Though  a  sys- 
tem of  preferential  taxes  can  be  elaborated,  it  is  peculiarly  open 
to  retaliation.  Tonnage  duties  may  be  made  higher  on  foreign 
ships  than  on  domestic ;  or  duties  on  goods  imported  in  foreign 
bottoms  may  be  made  higher.  But  this  sort  of  discrimination  in- 
vites easy  retaliation.  The  domestic  ships  so  favored  must  in  due 
time  go  to  foreign  ports,  and  in  those  ports  they  in  turn  may  meet 
the  same  sort  of  hostile  treatment.  Not  only  may  they  do  so, 
but  they  certainly  will.  Retaliation  of  this  sort  has  been  uni- 
versally applied.  Hence  all  countries  have  found  themselves 
compelled  to  enter  on  reciprocity  arrangements  for  vessels  en- 
gaged in  the  direct  trade  between  them,  and  have  agreed  to  treat 
domestic  and  foreign  vessels  on  the  same  terms.  Coastwise 
shipping  —  from  one  port  to  another  in  the  same  country  (in- 
cluding colonies)  —  is  of  course  not  subject  to  this  limitation, 
and  here  protection  can  be  applied  without  hindrance.  Most 
countries  which  maintain  protection  in  any  form  apply  it  to  the 
coasting  trade,  usually  by  excluding  foreigners  once  for  all. 


532  INTERNATIONAL  TRADE 

For  shipping  in  the  foreign  trade,  the  only  available  protective 
policy  is  that  of  direct  subsidy.  The  difference  between  this  and 
protection  through  duties  is  one  of  method  only.  In  the  case  of 
subsidy  the  community  is  called  on  to  pay  money  directly  in 
order  to  promote  a  particular  industry.  In  the  case  of  protective 
duties  it  is  called  on  to  pay  indirectly,  in  the  form  of  higher 
prices  to  those  engaged  in  a  particular  industry.  The  subsidy 
or  bounty  method  has  been  applied  in  other  cases  than  ship- 
ping ;  frequently  in  older  times,  more  sparingly  in  our  own  day. 
For  example,  it  was  applied  in  1890  in  this  country,  when  the 
duty  on  sugar  was  abolished,  and  the  domestic  producers,  who 
had  previously  had  the  benefit  of  higher  prices  because  of  an 
import  tax,  were  given  a  direct  bounty  of  the  same  amount  (two 
cents  a  pound)  on  the  domestic  product.1  A  bounty,  or  subsidy, 
however,  is  a  much  less  insinuating  method,  and  much  more 
likely  to  become  unpopular.  Import  duties,  though  they  come 
in  essentials  to  the  same  thing  as  bounties,  can  be  defended  by 
a  host  of  persuasive  though  fallacious  arguments ;  but  the  direct 
payment  of  money  to  a  favored  industry  presents  in  unmistak- 
able form  the  question  whether  it  is  really  worth  while  thus  to 
tax  the  community.  From  the  free  traders'  point  of  view,  this 
very  simplicity  is  an  argument  in  favor  of  using  in  all  cases 
bounties  and  subsidies  rather  than  import  duties. 

National  pride  and  prejudice  have  been  important  factors  in 
promoting  the  growth  of  protective  feeling,  and  have  been  par- 
ticularly so  in  regard  to  shipping.  The  Stars  and  Stripes  have 
disappeared  from  the  seas :  here  is  the  most  effective  popular 
argument  in  favor  of  shipping  subsidies.  Vaguely  associated 
with  this  are  the  arguments  in  favor  of  a  merchant  marine  as  a 
means  of  supplementing  a  fighting  navy.  This  combination  of 
sentiment,  military  glory,  and  serious  political  considerations 
belongs  outside  the  strict  scope  of  economics.  But  the  drift  of 
all  rational  economic  thinking  is  against  subsidies  to  shipping, 

1  That  bounty  was  abolished  in  1894,  when  the  sugar  duty  was  reimposed. 
The  only  industry  for  which  a  bounty  has  been  advocated  of  late  in  this  country 
is  shipping. 


SOME  ARGUMENTS  FOR  PROTECTION  533 

as  indeed  it  is  against  all  jingoism.  Soberly  considered,  merchant 
ships  are  but  implements  for  promoting  the  division  of  labor, 
and  the  Stars  and  Stripes  on  them  are  cause  for  pride  only  if 
the  ships  are  made  and  handled  to  the  real  advantage  of  the 
community.  Soberly  considered,  battleships  are  prima  fade 
a  waste;  if  a  necessity,  a  sad  one;  and  not  to  be  built  one 
iota  beyond  the  limits  of  clear  necessity. 

§  4.  Considerations  as  to  general  social  soundness  are  supposed 
by  some  to  strengthen  the  case  for  free  trade,  by  others  that  for 
protection.  But  it  is  doubtful  whether  a  strong  case  can  be 
made  out  on  such  grounds  either  way.  It  is  said  by  the  pro- 
tectionists that  diversified  industry  has  social  and  educational 
advantages,  and  that  a  community  whose  occupations  have  a  very 
narrow  range  will  be  deficient  in  intelligence  and  adaptability. 
In  view  of  the  degree  of  industrial  diversity  which  is  certain  to 
appear  under  any  circumstances  in  a  modern  country  of  advanced 
civilization,  this  sort  of  vague  allegation  has  no  probative  force. 
Possibly  more  can  be  found  in  the  free  traders'  argument  that  a 
diversity  of  industries  secured  by  the  promotion  of  manufactures 
at  the  expense  of  agriculture  brings  social  and  political  draw- 
backs. Manufactures  mean  large-scale  production,  concentra- 
tion in.  comparatively  few  hands  of  management  and  probably 
of  ownership,  dependence  of  workmen  on  wages  by  hire,  increasing 
inequality.  They  mean,  too,  crowding  in  cities,  and  the  tempta- 
tion to  employ  women  and  children.  In  the  earlier  part  of  the 
nineteenth  century  arguments  of  this  sort  were  much  used  in 
the  United  States  against  protection.  They  were  not  without 
weight ;  they  are  not  without  weight  even  now.  The  soundest 
parts  of  our  American  nation  are  in  those  regions  of  the  North 
where  agriculture  is  still  the  dominant  industry.  But,  after  all, 
the  mode  in  which  an  industry  is  conducted,  and  the  character 
of  the  people  engaged  in  it,  are  more  important  than  the  nature 
of  the  industry  itself.  The  workingmen  of  the  English  manu- 
facturing districts  in  Lancashire,  Yorkshire,  and  Scotland  are 
better  social  stuff  than  the  agricultural  laborers  of  eastern  Ger- 
many and  probably  even  than  most  of  the  peasant  proprietors  of 


534  INTERNATIONAL  TRADE 

France.  Protection  and  free  trade  are  minor  factors  as  compared 
with  the  diffusion  of  education,  the  general  range  of  intelligence, 
the  distribution  of  wealth  and  income,  the  demarcations  of 
social  classes,  political  and  industrial  freedom. 

A  special  application  of  social  and  political  arguments  has 
recently  been  made  in  Germany,  combined,  however,  with 
reasoning  of  a  strictly  economic  sort.  There  the  controversy 
has  been  between  the  advocates  of  the  Agrarstaat  and  of  the  In- 
dustriestaat,1  the  former  being  in  favor  of  duties  on  grain  and 
other  agricultural  products,  the  latter  opposed  to  them.  To  the 
former  —  the  protectionists  —  dependence  on  foreign  countries 
for  indispensable  foodstuffs  seems  to  bring  evils  and  dangers. 
An  agricultural  population,  or  at  least  one  with  a  due  propor- 
tion settled  on  the  land,  is  thought  to  be  better  social  material 
than  one  mainly  engaged  in  manufactures.  A  great  develop- 
ment of  manufactures,  moreover,  and  a  dependence  on  foreign 
markets  for  disposing  of  the  products,  bring  uncertainty. 
Hostile  tariffs,  or  the  loss  of  the  advantage  in  production 
on  which  the  exportation  rests,  may  put  an  end  to  the  trade 
and  endanger  the  established  industries.  Finally  —  and  here 
the  crux  of  the  arguments  is  reached  —  the  present  relations  be- 
tween the  European  manufacturing  countries  and  the  oversea 
countries  from  which  they  get  food  are  essentially  temporary,  — 
temporary,  that  is,  compared  with  a  nation's  life  history.  The 
supply  of  food,  and  especially  of  wheat,  from  the  United  States, 
Argentina,  Canada,  rests  on  predatory  cultivation.2  The  contin- 
uous cropping  of  the  soil  can  be  maintained  only  so  long  as  new 
land  is  still  available.  Sooner  or  later — and  it  will  be  soon,  say 
these  protectionists  —  the  virgin  lands  will  all  be  occupied ;  and 
then  a  conserving  cultivation,  with  varied  crops,  must  come. 
Meanwhile,  population  in  these  new  countries  increases  rapidly, 
their  own  consumption  of  foodstuffs  becomes  greater,  their 
economic  situation  becomes  steadily  less  favorable  to  the  expor- 

1  The  German  word  "Industrie"  means  "manufactures."  It  is  often  mis- 
understood and  mistranslated  to  mean  "industry." 

1  See  what  is  said  in  Book  V,  Chapter  42,  §  5,  on  predatory  cultivation. 


SOME  ARGUMENTS  FOR  PROTECTION  535 

tation  of  grain  and  the  like.  This  transition  has  already  begun 
in  the  United  States,  hitherto  the  greatest  exporter  of  agri- 
cultural produce.  It  must  set  in,  with  time,  in  other  such 
countries  also. 

Hence  those  old  countries  in  which  great  manufactures  develop, 
based  on  an  exchange  of  the  manufactured  products  with  im- 
ported food,  must  face  the  possibility,  nay  the  probability,  of  an 
eventual  revulsion.  Food  will  no  longer  be  obtainable  by  im- 
portation. The  manufacturing  population  must  then  go  back, 
in  part,  to  the  land.  But  this  population,  under  the  stimulus  of 
plentiful  employment  and  cheap  food,  will  have  become  large, 
and  an  endeavor  to  support  it  at  home  will  meet  all  the  obstacles 
of  diminishing  returns  from  land.  The  example  of  England  is 
held  up  as  a  warning.  Her  great  population,  which  the  coun- 
try's own  resources  cannot  possibly  supply  with  food  and  ma- 
terials, is  necessarily  dependent  on  foreign  trade,  and  must  be 
constantly  uneasy  lest  the  process  of  exchange  with  other  coun- 
tries may  fail. 

There  is  much  validity  in  this  train  of  reasoning.  As  put  forth 
by  careful  thinkers,  it  admits  the  prima  facie  loss  from  protection. 
It  would  seem  plain  that  in  the  present  generation  food  is  got 
cheaper  by  foreign  trade,  and  that  the  exchange  of  manufactures 
for  food  is  for  the  time  being  advantageous.  True,  some  of  the 
ardent  protectionists  hesitate  in  this  sort  of  admission,  as  people 
commonly  hesitate  and  minimize  in  concessions  to  their  oppo- 
nents ;  but  the  admission  must  be  made.  It  must  be  admitted, 
also,  that  the  process  of  checking  the  growth  of  manufactures  by 
making  foodstuffs  dear  is  a  trying  one.  It  is  a  sacrifice  to  the 
apparently  distant  future,  which  in  the  present  generation  must 
be  unpopular.  But  where  the  sentiment  of  nationality  is  strong, 
and  the  welfare  of  coming  generations  is  prized,  such  sacrifice 
may  be  called  for. 

To  go  into  all  the  details  of  the  controversy  on  Agrarstaat  and 
Industriestaat  would  pass  the  limits  of  this  book.  The  free 
traders  aver  that  in  a  country  of  great  extent  and  diversified 
climate  like  Germany,  no  such  extreme  development  of  manu- 


536  INTERNATIONAL  TRADE 

factures  as  in  England  is  to  be  looked  for ;  that  the  probability 
of  failure  of  supplies  from  food-exporting  countries  is  exagger- 
ated ;  that  if  there  comes  eventually  a  check  to  the  exchange  of 
manufactures  for  food,  it  will  be  by  no  sudden  disastrous  halt, 
but  by  a  gradual  process  to  which  industry  and  population  can 
adjust  themselves ;  and  finally  that,  in  the  present,  the  burden 
of  import  duties  is  heavy,  and  that  the  chief  beneficiaries  are 
a  small  knot  of  large  landed  proprietors.  The  main  economic 
argument  of  the  protectionists,  as  to  the  future  failure  of  food 
supplies,  raises  a  question  difficult  in  many  directions, — namely, 
how  far  it  is  wise  to  go  in  the  restriction  of  immediate  satisfac- 
tions for  the  sake  of  a  distant  and  more  or  less  uncertain  future. 
Shall  we  now  husband  our  coal  supplies,  which  we  know  to  be 
limited  ?  Or  shall  we  use  them  freely  according  to  present  needs, 
partly  indifferent  to  the  future,  partly  trusting  to  possible  dis- 
coveries and  improvements  for  other  sources  of  heat  and  power  ? 
Shall  the  Germans  (and  English,  too)  persist  in  a  policy  of  free 
trade  and  of  dependence  on  foreign  countries  for  food  and  ma- 
terials needed  now,  without  speculating  too  anxiously  upon  the 
continuance  of  these  supplies  in  the  uncertain  future?  It  is 
easy  to  err  in  endeavoring  to  provide  too  carefully  for  coming 
generations.  Such  are  some  of  the  large  problems  which  the  pro- 
tective controversy  now  presents  in  a  country  like  Germany,  — 
problems  which  give  fair  ground  for  differences  of  opinion,  and 
involve  considerations  much  weightier  than  those  usually  put 
forward  by  protectionists  in  the  United  States. 

§  5.  A  somewhat  different  phase  of  the  tariff  controversy 
has  appeared  in  England.  There  the  steps  towards  a  manufac- 
turing nation  (Industriestaat)  have  been  irrevocably  taken,  and 
the  question  is  as  to  the  best  means  of  remaining  with  safety 
and  prosperity  in  this  far-developed  stage.  It  would  seem  at 
first  sight  that  here  a  policy  of  free  trade  alone  is  tenable.  Yet 
the  reaction  against  it  has  appeared  in  England  also,  and  not 
without  the  support  of  effective  arguments.  These  arguments, 
so  far  as  they  are  really  of  weight,  all  turn  on  the  expediency  of 
reciprocity  arrangements. 


SOME  ARGUMENTS  FOR  PROTECTION  537 

In  the  preceding  pages  it  has  been  said  more  than  once  that 
exaggerated  importance  is  commonly  attached  to  a  country's 
exports.  For  a  country  in  England's  situation,  however,  there 
is  substantial  ground  for  watching  the  exports  with  special  care, 
and  perhaps  with  some  anxiety.  They  are  the  means  for  ob- 
taining indispensable  imports.  The  alternative  of  producing  the 
imports  at  home  —  of  turning  the  labor  and  capital  from  mak- 
ing the  things  exported  to  making  those  now  imported — hardly 
exists.  England  must  import ;  and  in  order  to  import,  she  must 
export.  Hence  every  event  which  lessens  the  market  for  ex- 
ports must  cause  concern.  Among  those  events  is  the  imposi- 
tion of  protective  duties  elsewhere.  It  is  a  matter  of  large  con- 
sequence for  England  to  maintain  in  other  countries  an  open 
market  for  herself.  Hence  the  advocacy  of  imperial  federa- 
tion, or  imperial  preference  duties,  as  a  means  of  inducing  the 
colonies  to  relax,  if  not  to  give  up,  their  duties  on  English 
goods;  and  hence  the  advocacy  of  duties  on  foreign  goods  in 
England,  as  a  means  of  chaffering  with  other  countries  in  nego- 
tiations for  the  reciprocal  reduction  of  tariff  barriers.  In  Eng- 
land, as  in  Germany,  and  indeed  in  all  countries,  the  vulgar 
fallacious  arguments  in  favor  of  protection  play  a  large  part  in 
the  popular  controversy :  increased  employment  for  home 
labor,  support  of  domestic  industry,  tribute  to  foreigners  in 
payments  for  imports,  and  so  on.  But  these  arguments  are 
more  insidiously  dangerous  in  England  than  anywhere  else. 
That  country  depends  for  its  very  existence  on  manufacturing 
industries  which  are  able  to  face  the  competition  of  the  world. 
If  once  her  own  industries  really  lean  on  protection  against 
foreigners,  her  knell  is  sounded.  The  only  solid  ground  for 
advocating  duties  is  to  enable  the  diplomatists  to  higgle  for 
lowered  duties  elsewhere.  And  the  only  ground  for  preferential 
arrangements  with  the  colonies  is  to  induce  them  to  admit 
English  goods  with  no  duties  or  with  lowered  duties. 

In  its  direct  economic  effects,  the  levy  of  duties  on  imports 
in  retaliation  for  duties  elsewhere  on  a  country's  exports,  makes 
the  situation  not  better,  but  worse.  If  Germany  levies  duties 


538  INTERNATIONAL  TRADE 

on  English  goods,  the  advantages  from  the  division  of  labor 
between  the  two  countries  are  lessened  by  so  much.  If  Eng- 
land then  levies  duties  on  German  goods,  those  advantages  are 
lessened  by  so  much  more.  If,  indeed,  one  takes  a  Mercantilist 
view  of  foreign  trade,  and  assumes  that  its  chief  object  is  to 
procure  a  market  for  the  exports,  then  retaliation  and  reci- 
procity assume  a  different  aspect.  Then  a  country  becomes 
always  intent  on  increasing  its  exports,  and  always  uneasy  at 
increasing  its  imports;  and  then  it  will  perhaps  consent  to 
admit  the  imports  more  freely  only  if  tempted  by  a  bait  of 
selling  exports  more  freely.  So  long  as  this  state  of  mind 
exists,  there  is  at  least  a  possibility  of  securing  an  eventual  relax- 
ation of  restrictions  by  first  imposing  restrictions. 

What  may  be  the  substantial  grounds  for  expecting,  in  the 
case  of  England,  a  real  extension  of  international  trade  by  this 
process,  it  is  difficult  to  say.  Adam  Smith  remarked  that  this 
matter  was  not  for  the  economist,  but  for  that  crafty  and 
insidious  animal  called  the  statesman  or  politician.  The 
stanch  free  traders  aver  that  other  countries,  and  the  English 
colonies  also,  will  go  their  way  undisturbed  by  retaliatory 
duties  or  preferential  offers,  or  will  make  concessions  that  are 
only  nominal ;  and  that  England  herself  will  suffer,  and  in  no 
way  gain,  from  her  own  restrictions.  On  the  other  hand,  it 
must  be  admitted  that  the  Mercantilist  notions  persist  with 
extraordinary  tenacity.  The  immense  majority  of  persons 
think  of  a  reduction  of  duties,  not  as  a  gain  to  their  own  country, 
but  as  a  favor  shown  to  the  foreigner;  and  conversely  they 
think  of  tariff  reductions  by  foreigners  as  the  opportunity  to 
sell  more  goods  abroad  and  profit  thereby. 

§  6.  The  growth  of  protection  during  the  last  generation  has 
been  a  remarkable  phenomenon,  in  view  of  the  weight  of  rational 
opinion  against  most  of  the  arguments  commonly  advanced 
for  it.  Half  a  century  ago,  —  that  is,  during  the  generation 
following  the  repeal  of  the  English  corn  laws  in  1846,  —  the 
indications  seemed  to  be  that  free  trade,  or  at  least  a  great 
relaxation  of  customs  barriers,  would  extend  over  the  civilized 


SOME  ARGUMENTS  FOR  PROTECTION  539 

world.  But  in  the  decade  1870-1880  the  current  began  to 
turn  the  other  way.  Country  after  country  has  set  toward 
protection,  and  England  is  the  only  one  that  has  held  con- 
sistently to  unrestricted  trade.  The  protectionist  reaction  is 
explicable  on  various  grounds.  The  growth  of  nationalist  feel- 
ing is  one  important  cause.  Protection  seems,  to  most  people, 
a  "national"  policy,  and  in  fact  is  so,  in  the  sense  of  causing 
exchanges  to  be  made  within  a  country  rather  than  between 
countries.  The  principle  of  free  trade  has  a  certain  cosmo- 
politan flavor,  and  assumes  (as  well  as  promotes)  a  spirit  of  peace 
and  good  will  among  the  nations.  Another  cause  has  been  the 
breakdown  of  the  British  school  of  political  economy,  and  the 
admitted  need  of  a  thorough  reconstruction  of  economic  theory. 
This  has  promoted  skepticism  as  to  free  trade,  which  was  one 
of  the  cardinal  doctrines  of  that  school ;  although  no  part  of  the 
system  of  the  older  economists  has  stood  the  test  of  time  and 
criticism  better  than  their  reasoning  about  international  trade. 
Still  another  cause  has  been  the  competition  of  oversea  countries 
with  the  agricultural  producers  of  the  Continent.  The  landed 
interest  there,  formerly  indifferent  or  hostile  to  duties,  has 
joined  in  the  demand  for  protection  against  underselling  for- 
eigners. At  all  events,  during  the  last  generation  a  wave  of 
protection  has  succeeded  the  previous  one  of  free  trade. 

There  are  some  indications  of  a  movement  the  other  way,  — 
a  reaction  toward  lower  duties  again.  The  game  of  obstruct- 
ing imports  has  been  played  by  the  various  countries,  each 
against  the  other,  to  such  an  extent  that  they  seem  to  be  get- 
ting weary  of  it.  They  have  resorted  to  reciprocity  arrange- 
ments as  a  method  of  reaching  a  more  liberal  policy ;  and  this 
is  likely  to  be  the  method  of  the  immediate  future.  Whatever 
the  grounds  on  which  this  new  movement  rests,  and  whatever 
the  methods  used,  almost  all  economists  regard  it  with  favor. 
The  rampant  protectionism  which  has  taken  such  hold  in 
France,  Germany,  Russia,  above  all  in  the  United  States,  has 
the  support  of  few  sober  thinkers;  though  there  are  many 
economists  to  whom  unqualified  free  trade  seems  to  bring  diffi- 


540  INTERNATIONAL  TRADE 

culties  of  its  own.  Whether  England,  in  a  general  movement 
toward  reciprocity,  would  profit  more  by  holding  aloof,  and 
accepting  only  the  results  of  lower  duties  as  arranged  by  the 
other  countries;  or  whether  she  would  gain  by  threatening  to 
impose  duties  of  her  own  and  thus  entering  actively  into  the 
bargaining  process,  —  these  are  questions  to  which,  to  repeat, 
no  certain  answers  can  be  given,  and  which  must  be  left  for 
the  English  people  and  statesmen  to  decide  as  best  they  can. 

§  7.  In  the  United  States  a  severely  protective  tariff  was 
maintained  for  half-a-century  after  the  Civil  War.  The  finan- 
cial exigencies  of  the  war  caused  high  duties  to  be  levied,  and  in 
subsequent  years  these  were  retained.  A  rigid  and  all-inclusive 
system  of  protection  grew  up,  and  persisted  without  serious 
modification  (barring  a  brief  reaction  in  1894-97)  until  1913, 
when  a  considerable  general  reduction  of  duties  was  made. 

The  economic  effects  of  this  system  it  is  impossible  to  follow 
empirically.  We  have  seen  that  its  effects  on  the  terms  of  inter- 
national exchange  are  so  interwoven  with  those  of  other  factors 
that  no  unraveling  is  possible.  Even  more  baffling  is  the  task 
of  following  or  measuring  its  effects  on  general  prosperity.  The 
protectionists,  on  this  subject,  as  on  the  rate  of  wages,  have 
preached  and  protested  that  all  good  things  come  from  their 
tariff.  Such  talk  results  naturally  from  the  exigencies  of  parti- 
san conflicts  and  the  need  of  simple  arguments  for  the  mass  of 
voters.  So  loud  and  persistent  has  been  the  talk  that  for  many 
persons  not  unintelligent  it  has  become  an  article  of  faith  that 
the  prosperity  of  this  country  rests  on  the  protective  tariff. 
Yet  there  is  no  greater  delusion.  A  multitude  of  factors  explain 
our  general  welfare,  —  vast  resources,  a  far-spread  division  of 
labor  within  the  country,  a  free,  active,  and  intelligent  popu- 
lation. Has  not  this  North  American  region  been  for  centuries, 
under  all  sorts  of  economic  and  political  conditions,  the  envy 
of  the  world?  But  to  trace  in  detail  the  part  played  by  any 
one  factor  in  promoting  or  retarding  the  enviable  outcome,  is 
well-nigh  impossible.  Certain  it  is  that,  so  far  as  the  tariff  is 
concerned,  we  must  rely  chiefly  on  general  reasoning.  The  first 


SOME  ARGUMENTS  FOR  PROTECTION  541 

and  obvious  effect  of  protection  is  to  turn  industry  into  less 
advantageous  channels ;  and  there  is,  in  my  judgment,  no  good 
case  to  rebut  this  prima  fade  conclusion,  and  to  establish  a 
balance  of  gain,  from  such  a  tariff  system  as  the  United  States 
has  had  since  the  Civil  War. 

The  protective  duties  have  caused  a  real  burden  of  taxation 
for  the  community,  —  a  burden  alike  as  to  the  things  imported 
and  as  to  those  whose  domestic  production  has  been  brought 
about.  True,  the  duties  on  imports  have  yielded  revenue.  But 
they  have  led  to  public  extravagance.  The  persistence  in  main- 
taining high  duties,  and  the  inflow  of  many  imports  over  the 
barrier  of  the  tariff,  have  resulted  in  greater  revenues  than  was 
expected  or  desired,  and  have  promoted  wasteful  expenditure. 
The  main  burden,  none  the  less,  certainly  the  burden  specially 
due  to  protection,  has  appeared  in  the  higher  prices  of  the 
things  made  at  home.  That  burden  has  in  many  cases  been 
increased  for  the  consumer,  or  at  least  kept  heavy  for  him,  by 
monopoly,  temporary  or  permanent,  among  the  domestic  pro- 
ducers. It  is  small  comfort  that,  in  case  of  monopoly,  the  con- 
sumer's burden  may  represent,  not  national  loss,  but  diversion 
of  gain  to  favored  persons. 

Yet  it  should  be  said  that  on  many  articles  the  duties  have 
been  but  nominal.  These  articles  have  been  made  as  cheaply 
within  the  country,  and  (competition  being  active)  sold  as 
cheaply.  The  mere  imposition  of  a  duty  does  not  raise  prices. 
It  does  so  only  if  a  foreign  supply  is  cut  off,  and  a  more  expen- 
sive domestic  supply  is  thereby  induced,  or  a  domestic  monopoly 
fostered.  The  extent  to  which  manufacturing  industry  in  the 
United  States  is  dependent  on  the  tariff  system  is  vastly  ex- 
aggerated by  the  protectionists.  One  would  suppose,  from 
their  doleful  predictions,  that  not  a  chimney  would  smoke  but 
for  the  tariff.  In  fact,  the  United  States  is  certain  to  be  a 
great  manufacturing  country  under  any  conditions.  So  much 
is  assured  by  its  wonderful  resources  of  coal  and  minerals  and 
by  the  ingenuity  and  enterprise  of  its  people.  Its  comparative 
advantage  is  by  no  means  confined  to  agriculture.  But  this 


542  INTERNATIONAL  TRADE 

same  consideration  indicates  that  the  free  traders  have  gone 
too  far  in  ascribing  ill  effects  to  all  the  parts  of  the  protective 
system.  It  has  not  changed  the  course  of  industry  as  far  as 
their  charges  imply.  The  country  would  be  prosperous,  and 
would  have  greatly  diversified  industries,  without  a  high  tariff 
as  certainly  as  with  it. 

§  8.  The  conditions  on  which  depends  the  maintenance  of 
manufactures  in  a  country  like  the  United  States  deserve  a 
moment's  consideration.  Agriculture  still  remains  the  dominant 
industry,  though  not  as  pronouncedly  so  as  in  former  times. 
Some  manufactures  always  have  existed,  side  by  side  with 
agriculture,  from  the  very  necessities  of  the  case.  These  pro- 
duce what  we  have  called  domestic  commodities,  — •  those  not 
subject  to  foreign  competition  in  any  event.  The  manufac- 
tures whose  products  could  conceivably  be  supplied  by  impor- 
tation are  those  which  alone  present  the  tariff  problems.  With 
the  cheapening  of  transportation  and  the  crumbling  away  of 
special  national  ways  and  prejudices,  the  range  of  these  poten- 
tially competitive  manufactures  is  probably  widening.  They 
can  maintain  themselves,  in  a  state  of  freedom,  only  if  they 
have  as  great  a  comparative  advantage  as  agriculture.  They 
can  hold  their  own  against  foreigners  if  their  labor  is  more 
effective  in  the  same  degree  as  labor  in  agriculture  is,  or  if 
they  can  get  labor  on  unusually  cheap  terms.  Labor  may 
be  more  effective  (and  these  are  obviously  the  kinds  of  ad- 
vantage which  are  really  to  be  desired),  either  if  the  natural 
conditions  are  advantageous,  or  if  the  labor  is  intelligently 
directed  and  applied.  Both  these  causes  of  advantage  — 
natural  resources  and  intelligence  in  applying  labor  —  tell  in 
giving  the  United  States  an  advantage  in  agriculture.  Both 
tell,  also,  in  manufactures. 

The  exportation  of  wheat,  cotton,  corn  products,  from  the 
United  States,  though  in  large  part  the  result  of  favoring  condi- 
tions of  climate  and  soil,  depends  also  on  agricultural  machinery, 
well-selected  seeds,  cheap  transportation  to  the  railway  and  by 
the  railway.  The  exportation  of  some  manufactures  (or  things 


SOME  ARGUMENTS  FOR  PROTECTION  543 


\ 


classed  in  our  statistics  as  manufactures),  such  as  copper  and 
kerosene  oil,  depends  on  the  same  combination, — natural  re* 
sources  and  skill.  But  in  many  manufactures  which  are  exported 
the  advantage  seems  to  be  in  skill  only.  Such  are  sewing  ma- 
chines, agricultural  implements,  electrical  apparatus,  loco- 
motives. These  are  simply  made  better,  or  are  made  more 
cheaply  through  better  machinery,  because  of  Yankee  in- 
genuity. And  there  are  many  manufactures  which,  while  they 
do  not  export  heavily,  have  complete  possession  of  the  domestic 
field,  and  are  not  in  danger  of  competition  from  imports,  for 
the  same  reason;  such  as  boots  and  shoes,  pressed  glassware, 
the  commoner  grades  of  cotton  goods.  These  various  manufac- 
tures, quite  able  to  face  foreign  competition,  are  the  ones  which 
it  is  really  profitable  for  the  people  of  the  United  States  to 
have ;  and  their  range,  as  already  stated,  is  wider  than  would 
be  supposed  from  the  common  assertions  of  both  protectionists 
and  free  traders. 

The  usual  cause  of  advantage  in  manufactures  is  better 
machinery  and  methods.  Take  the  case  of  the  shoe  manu- 
facture, which  has  been  •  cited  as  one  of  our  efficient  and 
independent  industries.  Shoes  are  not  imported;  they  are 
beginning  to  be  exported  in  considerable  quantities.  The 
Americans  have  taken  the  lead  in  the  invention  and  perfection 
of  machinery  for  making  them.  But  machinery  can  be  bought 
or  copied.  The  Germans,  perhaps,  can  copy  it,  and  then, 
working  it  with  cheaper  labor,  can  undersell  the  Americans. 
This  is,  or  at  least  was,  often  true  of  the  Germans ;  they  have 
been  good  imitators,  though  slow  originators.  It  is  said  that 
American  steel  skates,  devised  and  perfected  in  the  United 
States,  were  copied  to  the  smallest  detail  in  Germany,  and 
then,  being  made  there  with  cheaper  labor,  were  imported  into 
this  country  again.  This  sort  of  imitation  is  not  always  pos- 
sible; since,  for  working  machinery,  a  force  of  intelligent  and 
skillful  mechanics  is  often  as  necessary  as  the  machinery  itself, 
and  is  much  more  difficult  to  copy.  But  the  thing  is  possible, 
if  not  always,  at  least  in  many  cases ;  and  the  more  so  if  ma- 


544  INTERNATIONAL  TRADE 

chinery  becomes  automatic.  The  salvation  of  the  industry 
then  is,  in  a  country  like  the  United  States,  incessantly  to  im- 
prove machinery.  Constant  progress  is  the  condition  of  main- 
taining the  comparative  advantage.  Once  the  same  methods 
—  that  is,  the  same  efficiency  of  labor  —  prevail  the  world 
over,  and  the  country  where  wages  are  lower  can  sell  cheaper.1 

It  is  comnionly  said  that  the  United  States  is  likely  to  have 
an  advantage  in  those  manufactures  where  machinery  is  much 
used.  This  is  true ;  but  the  real  explanation  is  not  often  given. 
The  mere  use  of  labor-saving  machinery  does  not  give  an 
advantage.  Machinery  represents  only  one  way  of  applying 
labor.  It  is  the  use  of  labor-saving  machinery  to  a  greater 
degree  or  in  a  more  ingenious  way  that  enables  the  output  to 
be  comparatively  cheap,  even  though  the  wages  of  laborers  be 
high.  In  those  industries  which  are  adapted  to  the  machine 
processes,  American  labor  is  likely  to  be  more  efficient.  Which 
those  industries  are,  cannot  be  settled  by  any  rule.  The 
march  of  invention  is  irregular.  Sometimes  Americans  take 
the  lead,  sometimes  Englishmen,  sometimes  Germans  or  French- 
men. It  is  proverbial  that  Americans  have  a  more  than 
creditable  record  in  this  sort  of  competition ;  and  the  economic 
corollary  is  that  they  do  well  to  confine  their  manufacturing 
activity  to  those  industries  in  which  they  seem  able  to  keep  in 
the  van. 

In  some  cases  in  the  recent  history  of  manufacturing  industry 
in  the  United  States,  it  is  to  be  admitted  that  this  process  of 
getting  the  lead  seems  to  have  been  promoted  by  protection. 
That  is,  protection  to  young  industries  has  been  successfully 
applied.  The  object  has  been  attained  by  a  rude,  blundering, 
expensive  method ;  but  in  fairness  we  must  grant  that  attained 
it  has  been.  The  silk  manufacture  has  already  been  cited  as 
an  example.  Possibly  the  iron  and  steel  manufacture  presents 

1  This  holds  true,  that  is,  of  any  one  industry.  If  all  industries  had  the  same 
methods  and  the  same  efficiency  the  world  over,  there  would  presumably  be  no 
differences  in  wages,  and  hence  no  trading  advantage  for  any  one  country  be- 
cause of  cheaper  labor.  International  trade  would  then  cease.  Cp.  Chapter 
34,  §  3. 


SOME  ARGUMENTS  FOR  PROTECTION  545 

another.  But  this  latter  case  is  more  doubtful,  because  the 
question  always  arises  whether  such  an  industry,  not  really 
new  to  the  country  (as  was  the  silk  manufacture),  would  not 
probably  have  grown  to  independence  under  any  circumstances. 
The  steady  increase  and  thickening  of  population,  and  the  grow- 
ing scarcity  of  free  land,  tend  in  any  event  to  bring  about  a 
development  of  other  than  agricultural  industry.  The  great 
stream  of  immigration,  and  the  altered  conditions  of  labor 
supply  thereby  brought  about,  strengthen  still  more  this 
tendency.  The  tariff  system,  even  where  it  may  seem  to  have 
acted  in  the  way  of  protection  to  young  industries,  has  often 
but  quickened  slightly  development  which  would  have  come 
soon  enough  without  it. 

§  9.  Making  all  possible  allowances  for  the  various  ways  in 
which  the  initial  burden  has  been  offset  in  the  United  States, 
there  probably  remains  a  heavy  debit  balance  against  protec- 
tion, through  the  creation  of  industries  dependent  upon  it. 
These  present  the  problem,  always  difficult,  of  the  claims  of 
vested  interests.  No  one  would  propose  that  persons  who 
had  in  good  faith  made  great  investments  in  plant,  on  the 
reasonable  supposition  of  the  continuance  of  the  protective 
policy,  should  be  deprived  of  the  protection  suddenly  and 
without  notice.  It  is  true  that  their  own  statements  regarding 
the  rates  of  duty  which  they  "need"  are  always  exaggerated, 
and  that  a  much  greater  reduction  is  usually  feasible,  without 
real  breakage,  than  they  are  willing  to  admit.  None  the  less 
breakage  is  to  be  avoided.  The  reaction  against  protection,  if 
it  should  come,  ought  to  proceed  by  gradual  and  tentative 
steps.  This  sort  of  consideration,  however,  need  not  be  shown 
with  regard  to  many  raw  materials,  in  producing  which  no 
considerable  plant  is  needed.  Such,  for  instance,  is  wool,  on 
which  the  United  States  long  maintained  a  heavy  duty,  not 
defensible  on  any  solid  economic  ground.  The  tariff  act  of 
1894  was  wisely  framed  so  far  as  it  abolished  once  for  all  the 
wool  duty;  this  was  the  one  bold  step  taken  in  that  unfor- 
tunate and  short-lived  measure.  The  wool  duty  was  again 
2> 


546  INTERNATIONAL  TRADE 

abolished  in  1913,  and  at  the  same  time  coal,  lumber,  hides, 
and  other  materials  were  made  free  of  duty. 

Nothing  has  been  said,  in  this  review  of  the  tariff  problem 
in  our  own  country,  of  some  of  its  more  obvious  bad  aspects, 
—  the  pressure  of  interested  producers  to  obtain  measures 
favorable  to  themselves,  the  contributions  of  a  semi-corrupt 
character  to  party  chests,  the  log  rolling  by  which  each  legis- 
lator strives  to  secure  in  the  general  scramble  duties  that  will 
be  of  benefit,  or  at  least  will  be  thought  of  benefit,  to  his  own 
constituents.  The  tendency,  in  popular  government,  for  each 
representative  to  press  the  real  or  supposed  interests  of  his 
special  constituents  is  the  greatest  evil  of  democracy.  It  has 
been  experienced  to  the  full  in  our  tariff  legislation.  But  it 
appears  in  many  directions,  in  things  good  as  well  as  in  things 
doubtful,  —  in  education,  harbor  improvements,  the  postal 
service,  public  control  of  railways  and  other  industries.  Some- 
thing of  the  sort  must  be  faced  whenever  the  state  undertakes 
to  direct  and  regulate  matters  of  economic  consequence.  We 
must  keep  in  mind  chiefly  the  general  outcome,  under  such 
working  conditions  as  the  existing  state  of  political  machinery 
makes  possible ;  and  from  this  point  of  view  the  question  of  pro- 
tection also  must  be  judged. 


REFERENCES  ON  BOOK  IV 

On  the  foreign  exchanges,  see  G.  J.  Goschen,  The  Theory  of  the  For- 
eign Exchanges  (last  ed.,  1901) ;  G.  Clare,  The  A  B  C  of  the  Foreign 
Exchanges  (1895) ;  H.  Withers,  Money-changing  (1913).  On  inter- 
national trade,  the  chapters  in  J.  S.  Mill,  Principles  of  Political  Economy 
(last  ed.,  1871),  Book  III,  Chapter  17  seq.,  though  in  some  parts  unduly 
elaborated,  are  still  unsurpassed.  A  good  modern  statement,  almost 
too  compact,  is  in  C.  F.  Bastable,  The  Theory  of  International  Trade 
(4th  ed.,  1903).  A  mathematical  treatment  is  in  three  papers  by  F.  Y. 
Edgeworth,  "The  Theory  of  International  Values,"  in  the  Economic 
Journal,  Vol.  IV  (1894).  I  venture  to  refer  also  to  my  own  paper  on 
"Wages  and  Prices  in  Relation  to  International  Trade,"  Quarterly 
Journal  of  Economics,  Vol.  XX,  August,  1906. 

Notwithstanding  the  mass  of  literature  on  free  trade  and  protec- 
tion, no  book  covers  the  controversy  satisfactorily.  H.  Fawcett,  Free 


SOME  ARGUMENTS  FOR  PROTECTION  547 

Trade  and  Protection  (1885),  states  the  simpler  reasoning  in  favor  of 
free  trade  and  refutes  the  cruder  protectionist  fallacies.  H.  G.  Brown, 
International  Trade  and  Exchange  (1914)  gives  a  good  compact  exposi- 
tion of  the  foreign  exchanges  and  of  the  principles  underlying  the  tariff 
controversy.  A.  C.  Pigou,  Protective  and  Preferential  Import  Duties 
(1906) ,  is  able  and  discriminating,  but  written  with  reference  chiefly  to 
the  contemporary  controversy  (1895-1905)  in  Great  Britain.  On  this, 
see  also  W.  J.  Ashley,  The  Tariff  Problem  (1903).  On  the  German  de- 
bates, see,  among  others,  L.  Pohle,  Deutschland  am  Scheidewege  (1902), 
and  A.  Wagner,  Agrar-und  Industriestaat  (1902),  both  in  favor  of  pro- 
tection for  agriculture ;  and  on  the  other  side,  L.  Brentano,  Die  Schrecken 
des  Industriestaates  (1901),  and  H.  Dietzel,  Weltwirthschaft  und  Volks- 
wirtschaft  (1900).  On  the  tariff  history  of  the  United  States,  E.  Stan- 
wood,  American  Tariff  Controversies  in  the  Nineteenth  Century  (1903),  a 
narrative  account  of  legislation  and  discussion  by  a  protectionist ;  and 
F.  W.  Taussig,  The  Tariff  History  of  the  United  States  (ed.  of  1914)  and 
Some  Aspects  of  the  Tariff  Question  (1915). 


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